Designation of retirement plan beneficiaries is increasingly common. According to the Pew Charitable Trusts, about 58 percent of U.S. workers now have access to an employer-sponsored defined contribution plan, and 49 percent participate in one. Often, it’s a decision that’s given little consideration because it seems so clear-cut to choose a spouse or other family member.
Yet taking this straightforward approach may not generate the best outcome. Consider this: the obvious choice for a beneficiary, such as a spouse or child, may not be the ideal choice.
Retirement plans may be subject to double taxation – through income taxes and possibly estate taxes – which can significantly impact what remains intact for family and loved ones. In fact, retirement accounts may be more heavily taxed than any other kinds of assets bequeathed. For individuals with a significantly-sized IRA or 401(k), this can appreciably diminish the overall inheritance someone leaves behind.
But when the beneficiary for a retirement account is a tax-exempt charity, those levies go away. As more and more people accumulate the bulk of their wealth in retirement accounts, donating these assets to a nonprofit might be the best way to protect heirs from adverse tax consequences.
The designation of a beneficiary, therefore, not only allows control over where retirement savings go, but also how much loved ones receive from an estate. Individuals should make retirement account beneficiary selections based on their overall estate planning objectives. And in order to receive maximum tax benefits, that might mean designating a charity.
One option is to name a specific nonprofit as a primary beneficiary. As a secondary beneficiary, an heir is named as the primary recipient, with a stipulation that the nonprofit receives the funds in their absence.
Another approach that derives the same tax benefits while offering more flexibility to fulfill charitable giving goals is to open a fund at the North Texas Community Foundation.
For example, a Donor Advised Fund can be created that allows children or grandchildren to continue participating in the way charitable funds are granted. Retirement accounts can also be used to establish a field of interest fund – allowing the Community Foundation to support nonprofits doing good work in a particular area such as the arts, education or animal welfare – or an unrestricted fund that allows grants to be need based on the most pressing needs of North Texas as they arise.
When to Consider It
When should this option be explored with a professional advisor? There are a variety of instances when it might be a good choice to think about charitable inclinations in regards to a retirement vehicle.
If an individual has no children, grandchildren or other close relatives, designating a nonprofit as the recipient of a retirement account ensures the money doesn’t pass on to the government.
Those who do wish relatives to receive their estate may want to allocate the retirement fund to a charity in order to benefit the heir’s tax situation. Rather than recipients being subject to a double hit on their taxes, gifting the fund to a nonprofit allows them to avoid both tax assessments.
This approach is particularly beneficial for anyone with a sizeable retirement account, or for anyone with an estate valued at more than $5.25 million ($10.5 million for a married couple) since anything above that amount is subject to federal estate taxes.
The next consideration is whether an individual is charitably minded. Using retirement vehicles for charitable giving is a good fit when parents want to benefit their children, but also fund important work in the community. For example, other assets or income besides a retirement account may be used to establish a life insurance trust for heirs – which can avoid estate tax if properly structured. Then, use the retirement vehicle to name a Donor Advised Fund or a Field of Interest Fund. This allows the children to receive proceeds from the parents and still benefit a charity.
When to Avoid It
There are times when designating a charitable beneficiary for a retirement account might not be the best option. For example, it might not be advisable when an individual’s heirs present unique circumstances, such as children who are minors or with special needs.
This approach is also not meant to usurp an individual’s desire to take care of family – such as grandparents who wish to provide for the education of their grandchildren.
Plan Now, Give Later
Retirement accounts are a key consideration in an individual’s overall estate planning activity. With foresight and preparation, they can reduce income tax burden, help loved ones receive more from an estate, and ensure nonprofits have much- needed resources.
Individuals who are interested in exploring this option can talk with a tax professional for recommendations. Or, call Nancy Webb, Director of Philanthropic Services at the North Texas Community Foundation, at 817-877-0702 for a consultation.