Investor's Business Daily, April 5th, 2007
Making charitable gifts with appreciated securities is generous. It also offers you tax benefits. As long as you have held the securities more than one year, you will get a deduction for their full value.
You will gain from the appreciation without having to pay capital gains tax.
But a good tax strategy for you may not work out best for your heirs.
Instead of using appreciated stocks or funds in a taxable account, make a charitable bequest from your IRA.
Suppose Alice Smith is a widow with two children. She has two assets. One is a traditional IRA with $500,000. The other is a portfolio of stocks worth $500,000.
The stocks were bought years ago. Smith's cost basis is $200,000.
Say Smith wants to leave $500,000 to charity and $500,000 to her children. She might do that by leaving the appreciated stocks to charity.
That way, her children will inherit the IRA. But they will owe income tax on every withdrawal.
Assume that Smith's children will owe 40% tax on withdrawals, counting federal and state income tax. The $500,000 IRA she leaves them is worth only $300,000, after-tax.
On the other hand, Smith could leave the appreciated stocks to her children. The charity could be named as beneficiary of her IRA.
At her death, the charity will receive $500,000 from the IRA. As a tax-exempt entity, it can withdraw funds without owing tax.
So the charity escapes tax either way. But Smith's children will be much better off if they inherit the appreciated securities. Under current law, they will inherit with a basis step-up to current value.
Say the securities are worth exactly $500,000 on the day Smith dies. That would give her children a $500,000 basis in those stocks.
They can sell for $500,000. They would owe no income tax. That would be better than inheriting a $500,000 IRA and paying tax on all withdrawals.
Split The Account
But even with a $1 million estate, you may want to leave much less than $500,000 to charity. No matter how large or small the bequest, at your death charitable donations should come from your IRA.
That will cut income tax your other heirs will owe on IRA withdrawals. And bequeathing assets from your IRA may leave more appreciated securities for loved ones, who will enjoy a basis step-up.
One way to make a partial charitable bequest from your IRA is to split the account. Say Smith wants to leave $50,000 to her alma mater.
She could transfer $50,000 from her $500,000 IRA to a new IRA. Her alma mater could be the beneficiary of this account.
Smith can monitor this IRA over the years, making sure that the amount in there is the amount she wishes to leave to the school.
For her original IRA, now a $450,000 account, her two children can be the beneficiaries. They will inherit the account at her death and not have to worry about the school.
"Many IRA owners prefer to run only one account," said Harry Rubins, a financial consultant in Santa Rosa, Calif. If that is your choice, you can include a charity or charities among the IRA beneficiaries.
Smith might designate her alma mater as a 10% beneficiary of her $500,000 IRA. Each of her children would be 45% beneficiaries.
There might be a tax trap to this strategy, though. When a charity is included among IRA beneficiaries, the account may have to be paid out relatively soon.
This can deprive your other heirs of valuable tax deferral.
In the above example, say that Smith dies at age 70. That is before she is required to take minimum distributions, which occurs after 701/2. The inherited IRA must be depleted by Dec. 31 of the fifth year after her year of death.
Or say Smith dies at age 89, while she is taking minimum required distributions from her IRA. Those distributions must be continued by beneficiaries, based on life expectancy for someone 89 years old: 5.9 years, on the IRS table.
"For greater tax deferral, the charitable beneficiary must be cashed out by Sept. 30 of the year following death," Rubins said. It doesn't matter how soon before that date the charity gets its gift.
The key is that the other IRA beneficiaries then can stretch distributions over their remaining life expectancies.
Live Long And Prosper
Suppose Alice Smith dies in 2007 with a $520,000 IRA and her alma mater is a 10% beneficiary. The other beneficiaries can direct the IRA custodian to distribute $52,000 to the school before Sept. 30, 2008.
Then Smith's two children can split the inherited IRA into their own inherited accounts, in the name of their deceased mother. They must act by Dec. 31 of the year after her death. If one son is, say, 58 years old, he can stretch required distributions over 27 years.
So if you plan to include a charity among IRA beneficiaries, make sure that your heirs know the rules. Tell them to cash out the charity by Sept. 30 of the year after death if they want maximum tax deferral.
Copyright 2007 Investor's Business Daily, Inc.
