Charitable Estate Gifts and their Primary Tax Benefits

Remember that if individuals include a charitable donation in their estate plan, the amount of the donation will be subtracted from the overall value of their estate. This reduction can decrease or even completely offset the value of the assets that are subject to estate taxes. Gifting certain assets can be more tax-efficient than others. 

Bequests and gifts of Life Insurance are wonderful for the nonprofit, but they aren’t always the most tax advantageous for the estate or other individual beneficiaries because they only reduce the value of the taxable estate. 

While gifting an Individual Retirement Account, Investment Account and/or Real Estate to charities circumvents additional taxes or penalties that would likely be incurred by individual beneficiaries and reduce the overall taxable estate!

Straight Bequest

A bequest is a gift, documented in a Will or Trust. The gift can be a specific amount or a percentage of the estate’s overall value. A bequest that is documented as a specific amount will be paid first and reduce the amount that is left to be divided as a percentage. Bequests may be distributed during the administration of an estate or once probate is closed, typically 9-12 months after death. Gifts made to charitable organizations are deducted from the overall value of the estate.

Gifts of Life Insurance 

Many adults purchase whole life or term life insurance policies when they are young, their children are young, and they have significant financial liabilities. Sometimes, when people mature and their kids grow up, they no longer need the life insurance policies they purchased earlier in life. That said, they’ve invested in the policy for years and if they stop paying, the investment has no return. 

If the policy owner continues to pay the premiums and names a nonprofit organization as the beneficiary of the policy, upon the donor’s death, the policy’s death benefit can be used to support a nonprofit’s mission. The policy’s death benefit can be deducted from the donor’s taxable estate. 

Life insurance, like IRAs, is passed to the beneficiaries outside of probate. Life insurance benefits are typically paid within weeks to months of the policyholder’s death. 

Charitable Beneficiary of an IRA

There are different types of tax deferred retirement accounts-Traditional and Roth. 

With a Traditional IRA, a 401(k) and a 403(b), contributions are made with “pre-tax” dollars, meaning participants do not pay taxes on the contributions made into the IRA, and investments grow tax free. That said, all withdrawals, whether before or after retirement age, are taxed as income on the annual, individual tax return. 

A Roth IRA, Roth 401(k), or Roth 403(b) is a retirement account in which contributions are made with “after-tax” dollars, meaning participants have already paid taxes on the contributions made into the retirement account, so they don’t have to pay taxes on the earnings within the account or their withdrawals. 

Both types of retirement accounts generally pass outside of probate, meaning funds are distributed to the beneficiary within a shorter timeframe (weeks to months after the account owner’s death). And, when gifted to a nonprofit organization, the value is deducted from the overall value of the estate, potentially lessening the estate tax burden.

Traditional IRAs, 401k and 403bs

The IRS considers the balance left in a pre-tax retirement plan to be untaxed income. Therefore, any individual beneficiaries will likely face federal and state income taxes on gifts from a retirement account. 

However, if a nonprofit is named as the beneficiary of these accounts, due to their nonprofit status, the gift will not be subject to state and/or federal taxes, meaning 100% of a gift will benefit the mission of the nonprofit organization. In addition, the charitable gift will be deducted from the taxable value of the estate. 

An Excellent Option:

If an estate plan has both individual and charitable beneficiaries, gifting this specific asset to the nonprofit has significant upside for everyone involved. Here is a balanced and lucrative strategy: The nonprofit is gifted the IRA ensuring 100% of the value of the fund goes to support the mission. The individual is gifted the remainder of the estate through the Will or Trust, which does not necessarily add to the beneficiary’s taxable income like the IRA assets would. And the full value of the IRA can be deducted from the overall estate value, lessening the tax burden.

Roth IRA Gifts

There are no required minimum distributions from a Roth IRA while a person is alive. This extends to nonprofit organizations after death. This means a Roth, often made up of highly appreciated securities can be donated to a nonprofit for continued investment, while also having access to tax free withdrawals. Like other retirement funds, all distributions must be made to the beneficiaries within 10 years.

Investment Account Gifts 

In contrast to individuals’ beneficiaries, nonprofits aren’t subject to capital gains taxes when they sell stocks and bonds held in an inherited investment account. Therefore, gifting investment accounts, especially those with appreciated securities like stocks or mutual funds, to a nonprofit is particularly appealing. 

The process of gifting these accounts is generally simple and flexible, allowing you to designate a nonprofit as a beneficiary to receive the assets directly upon your death, bypassing probate. 

Real Estate Gifts

Like investment accounts, when real estate is gifted to an individual beneficiary and sold, the individual will have to pay capital gains tax on the difference between the appraised value of the property on the date of death and the eventual sale price. However, nonprofits don’t have to pay capital gains tax, so no additional taxes are owed.

Real estate can be gifted through a Will, Trust, or through a transfer on death deed. 

Marketing Tip: 

Nonprofit organizations should always list the information advisors will need in order to properly gift Bequests, IRAs, Life Insurance, Real Estate, and Investment Accounts on their website. This includes the nonprofit’s legal name, physical address, and tax-identification number.