A Tax-Smart Strategy for Charitable Giving with Your IRA
A Simple Step, a Powerful Legacy: Naming Charities as Beneficiaries on Retirement Plans
When it comes to charitable giving, one of the simplest yet most powerful strategies is naming a charity as a beneficiary on your retirement accounts, such as IRAs or 401(k)s. It’s a straightforward way to make a significant difference—and it comes with unique tax advantages that amplify your gift’s impact.
Over my 30+ years as a CPA and financial advisor, this is one of the strategies I’ve used most often. It’s simple, effective, and incredibly powerful for turning a tax-heavy asset into a lasting gift for the causes you care about.
Why It Works So Well
Retirement accounts left to heirs are typically subject to income tax. For large accounts, this can significantly reduce the amount your loved ones receive. But charities are tax-exempt entities, meaning they can use every dollar without losing a portion to taxes. By naming a charity as a beneficiary, your retirement account’s full value goes to the cause you care about most. Additionally, unlike most inherited assets, retirement accounts do not receive a "step-up" in basis upon inheritance, further increasing the tax burden on heirs compared to other inherited assets such as brokerage accounts.
Consider this simple example: If you leave a $250,000 IRA to your child, and they pay 40% in taxes, your child ends up with $150,000. However, if you leave that same IRA to a charity, the charity receives the full $250,000 because they pay no taxes. In this scenario, the charity effectively gets 1.67x what your child would receive. That’s leverage.
If your estate is taxable (meaning your estate will owe estate taxes), this leverage becomes even more powerful. Instead of combining income and estate taxes that can further reduce what your heirs receive, you can direct the full, untaxed value of your retirement account to charity while leaving more tax-efficient assets to your heirs.
Additionally, IRS clarifications in recent years have made it easier to name both charitable and non-charitable beneficiaries on the same retirement account without jeopardizing the tax advantages for individuals. Previously, naming a charity alongside an individual risked having all beneficiaries treated as non-individual beneficiaries, which disqualified the individuals from taking advantage of longer allowable distribution periods afforded to individuals, such as the 10-year rule introduced by the SECURE Act.
However, the IRS has clarified that if the charity’s portion is distributed (and removed from the account) by September 30 of the year following the account owner’s death, the individual beneficiaries can still qualify as designated beneficiaries. This prevents the entire IRA from being “tainted” by the presence of a charitable beneficiary.
In simpler terms, imagine a pie representing your retirement account. You could always give a slice to charity and slices to individuals. But before, giving a slice to charity meant everyone had to eat their slices quickly (within 5 years). Now, you can give a slice to charity, and as long as you follow the rules to clearly separate the slices by the deadline, the individuals can eat their slices over a longer period (usually 10 years, thanks to the 10-year rule).
A Few Benefits of Naming a Charity as a Beneficiary
Tax Efficiency: Charities don’t pay taxes on inherited retirement accounts, maximizing the impact of your gift.
Ease of Setup: Potentially no legal fees or complicated trusts—just a quick update to your account paperwork. While straightforward in many cases, consulting an attorney may be beneficial depending on the complexity of your estate plan.
Leverage for Good: Transform a tax-heavy asset into a powerhouse for change, benefiting the causes you care about by transforming a tax-heavy asset into a tax-free legacy.
Clearer Guidance for Mixed Beneficiaries: Thanks to clarified IRS rules, combining charitable and non-charitable beneficiaries on the same account is now easier and more predictable. Meaning, this is not an all or nothing proposition - you can be more confident in dividing the account among multiple charities and family members.
One Step, Lasting Impact
Updating your beneficiary designations is simple and generally doesn't require redrafting all of your estate documents. By naming a charity as a beneficiary of your retirement account, you can turn a simple action into a powerful legacy. Whether it’s supporting education, healthcare, the arts, or any cause close to your heart, this strategy ensures your retirement savings make a lasting difference.
Take a moment to review your accounts and consider this impactful option. Over my career, this is one of the strategies I’ve used most often to help clients align their financial plans with their values. With clearer guidance from the IRS and the significant leverage of directing tax-heavy assets to charity, this is a step that can create ripples of impact far into the future. Taking this simple step today, and you could create a legacy that extends far beyond your lifetime, making a powerful difference for the causes you care about.