It’s Not Just What You Give, But How You Give It

For many, leaving a meaningful legacy involves more than just providing for loved ones. It may also include supporting a church, school, foundation, or charitable organization that has made a meaningful difference in your life. With thoughtful planning, family and charitable goals can work together as part of a well-designed estate plan.

Achieving both goals requires careful consideration of not only how much each beneficiary receives, but also which assets they receive. Assets of equal value can have very different tax consequences when inherited. Traditional IRAs, appreciated investments, real estate, cash and other assets each have unique tax characteristics. Understanding these differences can help determine how assets should be allocated between family and charitable beneficiaries to maximize the overall benefit of the estate.

Appreciated assets such as stocks, mutual funds and real estate generally receive a new tax basis equal to their fair market value at the owner’s death. This is commonly referred to as a “step-up in basis.” A beneficiary who sells an appreciated asset after inheriting it may recognize little or no capital gain if the sale price is close to its value at the owner’s death. For example, if you purchased an investment for $50,000 and it is worth $100,000 when you die, your children may inherit it with a basis of approximately $100,000. If they sell it for $100,000 shortly after, there could potentially be no capital gain from the sale.

Retirement accounts, however, are treated differently. A traditional IRA generally does not receive a step-up in basis for its unrealized appreciation. Instead, beneficiaries generally pay income tax as distributions are taken from the inherited account and the entire account generally must be distributed within 10 years of the account owner’s death. Certain eligible designated beneficiaries that include a surviving spouse, a minor child of the owner, a disabled individual or an individual who is not more than 10 years younger than the owner may qualify for a different distribution treatment.

These differences can make the selection of assets an important part of charitable planning. A qualified charity generally does not pay federal income tax on a distribution from a traditional IRA whereas an individual beneficiary may owe income tax on a taxable distribution. As a result, a retirement account can be an efficient asset to leave to charity. For example, if you intend to leave $100,000 to charity, you might consider naming the charity as the beneficiary of $100,000 of your IRA rather than giving the charity $100,000 of appreciated investments. Your family could then potentially receive the appreciated investments, which may receive a new basis at your death. The goal is not necessarily to give more to charity or less to your family, but to consider which assets may be most advantageous for each beneficiary.

Charitable giving can also be incorporated directly into beneficiary designations. Depending on the asset, you may be able to name a charity as a beneficiary of all or a portion of a retirement account, life insurance policy or other accounts that allow beneficiary designations. This can provide a straightforward way to include charitable giving in your estate plan while retaining control of the assets during your lifetime. Because beneficiary designations generally control who receives these assets, they should be reviewed periodically and coordinated with your will, trust, and overall estate plan.

Another approach is to leave a percentage of your estate or retirement account to charity rather than a fixed dollar amount. For example, you might designate 90% of your estate for family and 10% to charity. Defining a percentage-based gift can provide flexibility because the amount of the charitable gift changes with the value of the estate. If your estate grows, the charitable gift grows; if the estate decreases in value, the charitable gift will decrease in value as well.

Ultimately, charitable giving does not have to compete with providing for your family. Instead, the two goals can be incorporated into the same estate plan. By considering both the amount and the type of asset you would like each beneficiary to receive, you may be able to maximize the benefit to both your family and to charity.

As life circumstances and priorities can change, your estate plan should be revisited periodically. Changes in family circumstances, charitable interests, asset values, and tax laws can all affect whether an existing plan still reflects your goals. Taking the time to review these details periodically can help ensure your wishes remain up to date and that your assets continue to support the people and causes that matter most to you.