The Most Tax-Efficient Method of Leaving Assets to Charity in Your Estate

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There is no right or wrong decision in estate planning. There are only your wishes.  Before we die, we have the opportunity to leave any of our possessions to anyone we choose. It is your right to pass on your wealth to whomever or whatever you choose.

When I write about estate planning or work with clients on their own plans, it is my mission to encourage clients and readers to dream bigger until they have a plan they are truly satisfied with. One main bad outcome in estate plans is settling for a cookie-cutter estate plan when you needed a custom design.

The most common estate plan is fairly simple. First, the spouse inherits everything. Then contingently, the assets are divided among the children often per stirpes. After that, most people turn to their siblings, parents, nieces and nephews, or godchildren. After these family designations, the next most common is to leave some assets to charity. If you want ideas for heirs beyond that, you may enjoy reading “Five Beneficiary Ideas Other Than Family.”

Once you have finalized which entities and the amounts or percentages you want each entity to inherit, then you are ready to develop the most advantageous implementation of those wishes. Because of the unique tax-free status of charities and the difference in tax treatment between account types, if you have a charity among your heirs, there is the possibility for tax savings depending on which assets you give to which heirs.

Because of the tax privileged status of charities, they can ignore the tax owed on distributing assets from a traditional IRA. For this reason, some savvy investors with charitable estate intentions decide to leave some or all of their traditional IRAs to charity, while leaving family or friends the other assets such as Roth IRAs which are post-tax or taxable accounts which receive a step-up in cost basis.

Leaving your IRA to charity is most easily accomplished by putting a beneficiary designation on your traditional IRA which leave some assets to your Donor Advised Fund.

A donor advised fund (or Testamentary Donor Advised Fund) is a 501(c)(3) in its own right and can send its assets on to other charities. You can easily designate a Donor Advised Fund as a beneficiary both on your retirement accounts and in your estate plan. Then, if you ever change your mind on which charities you want to inherit this charitable share, free paperwork can be utilized to implement the changes rather than more estate attorney fees.

If you are engaging in systematic Roth conversions while also planning on leaving your IRA to charity, then those Roth conversions could be gradually reducing the amount you leave to charity. If that isn’t in line with your estate wishes, you may also benefit from mentioning the traditional IRA beneficiary designation in your trust or Will.

For example, your estate attorney could write into your trust (or will) that your trustee (or executor) should ensure that your target amount is left to charity when considering all of your assets, including assets inherited by beneficiary designations. In this way, your trust could round out the charity’s inheritance.

For example, if your target gift was 10% of your total estate, your IRA might leave 100% of your traditional IRA to charity, but that might amount to 3% of your whole estate. So then your trustee (or executor) would source the remaining 7% from the assets under their control. Or in a second example, your target gift might be 10% of your estate, but 100% of your IRA represents 11% of your estate, so your trustee (or executor) would not donate any more.

These kinds of clever solutions are how you can mold your estate plan to fit your estate wishes, rather than the other way around.

Photo by Vy Huynh on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.