Tax Tips – A Simple Estate-Planning Tip

This article shows you a great and somewhat unknown estate tax shelter and tax planning tip. This is something you can share with your accounting and bookkeeping service clients.

Many people have provided for their favorite charity in their wills. But not many people know about a simple technique that can accomplish their charitable giving goals — and pass more of their wealth on to their loved ones.

Here it is:  Instead of making an outright bequest in a will for charity, the individual should name the charity as a beneficiary of their company retirement plan or IRA. When they die, the charity will still get the amount they want it to — but their heirs will get a lot more.

This strategy is brought to you by a little concept known as “IRD.” This stands for “income in respect of a decedent.” When someone with a retirement plan dies and the proceeds of the plan are paid out, the money flows into the individual’s estate as IRD income. This money is taxable to the estate — and it may also be taxed as income to the person who ultimately receives it. When all of the taxing authorities get finished with IRD income, they can take around 80 percent of it. The individual’s heirs may see only 20 cents of every dollar the plan pays out.

Example:  Wilson has $300,000 in his 401(k) plan. In his will, he gives his retirement plan to his kids and he gives $100,000 to his favorite charity.
Result:  At death, the charity gets its $100,000 and the kids get their $300,000. But the kids also get this: a Form 1099-R. This form is sent to them by the retirement plan administrator because the $300,000 is taxable income to the kids.

In order for Wilson to leave more to his kids, all he has to do is eliminate the $100,000 to charity in his will. He also has to go to his employer to instruct it to send the first $100,000 from his 401(k) plan to charity when he dies.

New result:  The charity still gets its $100,000. And the kids still get their $300,000 — but $100,000 of it is a tax-free inheritance. They still get a 1099-R, but it’s for only $200,000 from the plan. The charity gets a 1099-R for the remaining $100,000 from the plan that it received. But the charity can rip it up because, as a tax-exempt organization, it pays no tax on this money.

This technique can also be used in conjunction with other assets that trigger heavily taxed IRD income. This includes savings bonds, unpaid bonuses, lottery winnings, unpaid rental income, and installment sales obligations.