When planning their estates, many people want to remember a charity, cause, or organization with a monetary gift, an honorable impulse. But the vehicle you use to make the charitable bequest can have a great impact not only on your heirs, but also the organization you’re trying to support.
It’s a very common mistake to include all of your assets in a will or revocable trust, which can have unintended tax consequences. Fortunately, there are easy remedies.
Keep in mind that what your heirs will actually inherit after your demise are the assets you earmarked for them — after taxes. So, when deciding how to structure your will or revocable trust, you want to always assess the tax consequences to your heirs of any and all classes of assets.
In the mix of investments most retired people have, there is almost always an IRA or 401K, for which the taxes are deferred throughout the life of the individual who owns the plan. When that person passes away, however, those taxes become due and payable by whoever inherits the proceeds of the plan.
That means that, if your heirs are the beneficiaries of a 401k or IRA, they will be hit with the taxes, whether immediately or whenever they begin to draw down the proceeds.
There is an exception, however: charities, churches, and some non-profit organizations would enjoy the windfall in its entirety because they are tax-exempt. So, essentially, you are giving the charity or organization that asset that would be least tax-efficient if your heirs were to receive it. You then can leave your heirs more tax-efficient investment vehicles, lessening the burden on them.
There are several added benefits that make this strategy even more appealing. Most, if not all, plans allow you to list several people or entities as your beneficiaries. It’s free, and you can also change them as often as you want, just by changing the beneficiary form. Even better: there’s no trip to the lawyer’s office, triggering additional fees, if you follow this plan.
(The only exception to this rule is a Roth IRA or a Roth 401k, which you can leave to your heirs tax-free. In that case, it’s probably easier to leave that asset in your will or trust.)
Smaller non-profits — houses of worship, for example — may not have the resources to file the paperwork necessary to receive the gift you’ve left them. Some IRA providers have a long list of requirements that must be met before the funds will be disbursed.
Or you may not have the ultimate confidence in the broker’s diligence to help and guide the charity in such a situation. In that case, you may want to consider a donor-advised fund, which will reduce complications immensely.
Feel free to contact any of the advisors at Coral Gables Trust Company for more details and guidance as to the best strategy for you, your family, and/or the charity of your choice.
As always, the critical thing is to plan, plan, plan. The bottom line: there are many different ways to leave assets to your heirs and others, and they have varying tax consequences attached.