Tax Smart Bequests for Heirs and Charities

The tax implications are different depending on which asset is being passed to your heirs or your favorite charities. Attorney and CPA Jim Lange explains how to maximize your gifts within your estate plan.
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By James Lange, CPA

The tax implications of your charitable contributions and leaving money to your heirs might not be the first thing you think about, but it is an important concern. So, what are some of the most important questions to ask before specifying bequests after you and your spouse die? If you are selective about who receives which type of money—whether traditional or Roth IRAs, after-tax brokerage accounts, life insurance, etc., you can decrease the amount going to the IRS and increase the amount going to your family. Now that’s a tax strategy most people can get behind, but you have to understand how taxes are assessed for each recipient.

James Lange

Jim Lange, CPA

For example, under most circumstances traditional IRAs are going to be fully taxable to your heirs. Furthermore, the SECURE Act made it mandatory that inherited IRAs (spouses are excepted from this rule) are fully disbursed within ten years of the IRA owner’s death. That means that all income taxes on the inherited IRA must be paid by the time ten years have passed. Inherited Roth IRAs offer better terms because they can continue to grow for ten years after your death and then can be withdrawn tax-free. Other investments, like after-tax money and life insurance, for the most part, are not subject to income taxes. As you can see, the tax implications are different depending on which asset is being passed to which recipient. But, here’s some good news: None of this applies if the beneficiary is a tax-exempt charity.

Here’s how this strategy could work for you:

An IRS recognized tax-exempt charity never has to pay taxes on the money it receives. Period. Traditional IRAs, Roth IRAs, after-tax dollars, or life insurance are all the same to them and gratefully accepted. Your heirs, on the other hand, will confront different tax implications depending on the type of asset they receive after your death. Please note that in this article, we are only addressing income taxes, not estate or transfer taxes.

Let’s assume you and your spouse want to leave $100,000 to charity after you both are dead. Your assets include traditional IRAs and after-tax dollars.

Frequently, in our financial services firm, when we review estate documents drafted by other practitioners, we find that charitable bequests are listed in the will or revocable trust. The disposition of your IRA and retirement plans, however, is not controlled by stipulations in your will or trust. IRAs and retirement plans are controlled by their specific beneficiary designations. So, if you name your favorite charity in your will or trust, you will likely be donating after-tax money and the effect is that your children’s inheritance is reduced by $100,000. But consider this: That after-tax money might be much more important to your children.

Now, let’s look at what might be a better scenario where a simple shift might be very beneficial to your heirs:

You and your spouse decide to leave $100,000 to charity through your traditional IRA or retirement plan by specifying that bequest in your beneficiary designations. The charity will be happy because it gets $100,000 tax free. Remember, if you leave the $100,000 from your IRA to your children, they will be responsible for the taxes on the income.

Let’s assume your heirs are in the 24% tax bracket, the taxes amount to $24,000 on the $100,000. They are left with $76,000 after paying Uncle Sam—not that’s not their favorite uncle, of course. If your heirs are in a higher tax bracket, or if they live in a state that taxes inherited IRAs, the tax bite is even worse.

Bottom line: By leaving the charity $100,000 from your retirement money, you are effectively making an additional gift of $24,000 to your children.

Here it is spelled out in a different format:

Scenario 1

Impact on charity: $100,000 and pay no tax

Impact on heirs: $100,000 via a traditional IRA - 24% taxes = $76,000

Scenario 2

Leave $100,000 to charity through your IRA beneficiary designations and $100,000 to your heirs in your will or revocable trust:

Impact on charity: $100,000 and pay no tax

Impact on heirs: $100,000 via a revocable trust and pay no federal tax

In this case, simply paying attention to the tax implications for the beneficiary saved the family $24,000. That money could ease the burden of a college education for a grandchild.

Here is one more idea to consider:

What if you have financially successful offspring? A little less money to them from your retirement funds would be fine by all. Can you leave even more to charity? By all means! What if your children were completely comfortable with their total inheritance being reduced by $100,000? This is leaving the after-tax bequests out of the picture.

Using the same tax implications, you could leave $131,579 to charity through your IRA or retirement plan beneficiary designation. The $131,579 IRA bequest will only “cost” your child $100,000 ($131,579 times 24% = $31,579). If you left that $131,579 IRA to your children instead of charity, your children would have to pay $31,579 in taxes leaving them $100,000.

So, spelled out in a different way, consider the information below.

Scenario 3

Leave $131,579 to charity through your IRA beneficiary designations:

Impact on charity: $131,579 and pay no tax.

Impact on heirs: If your heirs were to receive the $131,579 from your IRA, they would owe $31,579 in taxes, leaving them with $100,000; but by making the agreed bequest to charity, you effectively only remove $100,000 from your heirs’ total inheritance while at the same time increasing the charitable gift by $31,579.

Uncle Sam gets a much smaller piece of the pie in this scenario—but nobody really likes him anyway!

Moral of the story: Always consider the tax implications for each beneficiary.

About the Author: James Lange

James Lange, CPA/Attorney, is a nationally recognized IRA, 401(k), and retirement plan distribution expert. Lange is the author of several best-selling books that help IRA and retirement plan owners to get the most from their retirement plans using Roth IRA conversions and tax-smart planning as an integral part of the planning strategy. For more information, visit www.PayTaxesLater.com.

Investment advisory services provided by Lange Financial Group, LLC. Content provided herein is for informational purposes only and should not be used or construed as investment advice. All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful. 


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