Leverage Retirement Plans to Optimize Post-Mortem Philanthropy

You have some assets in a non-exempt stock portfolio and some more in your exempt retirement fund. You would like to give a hefty chunk of those assets to charity and the rest to your family when you die.


Which assets do you give to the charity?


The answer to this question may change if the Biden proposals become law. But, for now, let's assume they don't pass in their current form or that they don't apply to you because you are not one of those "wealthy taxpayers"[*1] the Biden rules would affect.


Under current rules,


A. The assets in the non-exempt portfolio get a "Stepped-up Basis" when they pass to your estate. That is, your appreciated assets (well,,, technically, they are your heirs' or estate's assets) now have a basis equal to their value on the date of your decease. If those assets are later sold, gain is computed using that basis. If sold soon after they are inherited, there is little or no gain (or, hopefully, loss) recognized for income tax purposes. Your heirs or charitable beneficiaries get the whole portfolio more-or-less tax free. If the assets have a basis of $100,000 after the step-up and sell for $100,000 when liquidated - the beneficiaries get $100,000.


B. The assets in the exempt retirement fund have a different tax status and a different fate: Those assets and the income they represent are called "Income in Respect of a Decedent." When they are distributed after your demise Income (and assets) in Respect of a Decedent do not receive a Stepped-up Basis. They are, instead, taxed as if you were receiving them yourself. In most cases, you deducted the contributions to the exempt account when you made them.[*2] So, without the step-up, the exempt plan assets have a basis somewhere near zero. When distributed, they are substantially 100% taxable to your beneficiaries. If your taxable beneficiary is in a 24% marginal Federal tax bracket and a 9.3% marginal state tax bracket, a $100,000 distribution nets them about $66,700. Between the two portfolios, you distributed $166,700 to your heirs and beneficiaries and gave the Fed and your state $33,300.


But, here is the spoiler: Charities pay no income tax (at least in this scenario [*3]). What happens if you give the non-exempt portfolio to your taxable beneficiaries, and the exempt portfolio to your charitable, tax exempt, beneficiaries.


The taxable beneficiaries receive $100,000 - free of tax because there is no gain recognition or tax.


So does the charitable beneficiary because charities do not pay income tax on contributions that support their exempt purposes.


In total - your heirs and charitable beneficiaries receive $200,000 - a $33,300 improvement over the reverse scenario, and $16,650 better than "going halvsies."


Not quite ready to make a final decision about which charity to support? Give the exempt account proceeds to a Donor Advised Fund and allow your heirs to share the fun (and responsibility) of deciding who gets them.


There are many ways to optimize your charitable or philanthropic actions - this is one of the simplest ones. Contact us to discuss other options [818] 489-4228 or steven@cambysesadvisors.com




[*1] "Wealthy" is a relative term: Most people define it as "somebody who makes more than I do" or "somebody who has more than I do..." That definition works well for everyone except Jeff Bezos and (possibly) Bernard Arnault.

[*2] This generalization applies only to "traditional" retirement accounts. ROTH accounts are a different story entirely. If your exempt retirement assets are in ROTH accounts, it's pretty close to irrelevant who gets what or from where since ROTH distributions are tax free to the recipient.

[*3] Exempt organizations do not pay income tax on their "exempt purpose" income or on contributions that support that exempt purpose. They may be subject to Unrelated Business Income Tax and/or any of several excise taxes. Private Foundations face several excises that public organizations do not face.

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