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Leaving a 401(k) to Charity: What Advisors Demand to Know

Submitted by American Endowment Foundation on May 24th, 2021

Past Dawn Jinsky, CPA, CFP^® , Invitee Columnist

In the form of helping clients navigate the many roads that pb to their financial and personal goals, we will at some bespeak reach the intersection of charitable planning and 401(yard) program avails. While 401(g)s have much in common with the broader group of qualified retirement accounts similar IRAs, there are also differences worth knowing since they may impact the advice you provide.

In that location are several reasons a client may choose a 401(one thousand) over other retirement saving vehicles, if they have admission to one:

• Annual contribution limits are higher than IRAs ($19,500 versus $26,000 in 2021),
• A client's employer may match contributions, and
• A customer who is yet working at age 72 (or age 70 ½ if born before July ane, 1949) can defer starting Required Minimum Distributions (RMDs) until they stop working (unless they are a 5% or greater possessor).

Whichever the case, the client's 401(grand) will likely represent a significant part of his or her estate, and information technology tin can play a major part in the client's charitable planning.

For income tax purposes, a 401(yard) is considered Income in Respect of a Decedent (IRD), pregnant that it remains a pre-tax asset later a client passes abroad.  Whereas investments outside of a qualified retirement plan get a step-up in basis upon death which eliminates unrealized capital proceeds, 401(k) avails are still taxable afterward death at ordinary income taxation rates when withdrawn. Therefore, maximizing a client's charitable bequest at expiry with 401(k) assets will yield significant income taxation savings.

For example, consider a customer who is a widow with one child, and who desires to leave her estate 50% to Kid and 50% to a Donor Brash Fund (DAF) which volition allow Child to carry on her legacy of charitable giving. Her estate is valued at $3,000,000 which includes a 401(k) worth $500,000 and the remainder held in her revocable trust. If she were to proper name her DAF and kid each equally a l% casher of her 401(m), and her trust distributes 50% to each, the result would exist as follows (assume Child is in the 35% federal income taxation bracket):

	TOTAL VALUE	DAF	Kid
Cash/Marketable Securities	$1,600,000	$800,000	$800,000
401(one thousand)	$500,000	$250,000	$250,000
Residence	$800,000	$400,000	$400,000
Other Personal Property	$100,000	$50,000	$fifty,000
Less: Income Tax		0	($87,500)
Total Received		$1,500,000	$1,412,500

_{Illustration based on current tax law as of 05/01/2021}

Now, assume you lot advise your client to name the DAF as casher of 100% of the 401(k), and have her trust allocate an corporeality equal to 50% of her total estate (i.e., inclusive of her 401(k)) to Child and the residuum to the DAF:

	TOTAL VALUE	DAF	Child
Cash/Marketable Securities	$1,600,000	$550,000	$1,050,000
401(yard)	$500,000	$500,000	0
Residence	$800,000	$400,000	$400,000
Other Personal Belongings	$100,000	$50,000	$fifty,000
Less: Income Taxation		0	0
Full Received		$one,500,000	$1,500,000

_{Illustration based on electric current tax law as of 05/09/2021}

The passage of the SECURE Act in 2019 has made naming a charitable beneficiary even more favorable than pre-SECURE Act. The SECURE Human activity eliminated the power for nearly beneficiaries of inherited 401(one thousand)south to defer income taxes over the course of their lifetimes. Unless a beneficiary is an "eligible designated casher", meaning a spouse, child under the age of majority, disabled or chronically ill, or less than 10 years younger than the account owner, the beneficiary must fully deplete the account within x years and recognize the income. This means that the income taxes can no longer be spread out over the life expectancy of the beneficiary, which may result in more income taxation paid on the inherited 401(k).

If a client wishes to name a charitable beneficiary for their 401(chiliad), they should get-go check with their plan administrator to make sure the 401(k) programme allows it. Different IRAs, some 401(k)southward may limit who is a permissible beneficiary. It is a best practise to contact the charitable organization's administrator for the entity's full legal name and Tax Identification Number for the beneficiary designation grade. Also different IRAs, a 401(k) requires a client's spouse to consent to naming anyone other than the spouse as a beneficiary, and then the applicable spousal waiver volition demand to be obtained and properly executed.  If the programme sponsor does not permit for a charitable beneficiary to be named, the client should plan to execute a tax-free rollover of the 401(k) account to an IRA when it makes economic sense then that he or she can take full command over naming the casher.

However, if a client is married, you should bank check starting time if the customer's spouse is 10+ years younger than the client. If so, keeping the spouse as the primary beneficiary will allow the client to reduce their RMD, since they tin can use the more favorable articulation life expectancy table to figure the RMD amount, thus lowering their income tax liability annually. A workaround in this case is to keep the spouse every bit the master casher, name the clemency equally the secondary casher, and have the spouse agree to disclaim their involvement in the 401(k) should this exist necessary. In such cases, a DAF works well, since the surviving spouse retains the ability to direct those charitable assets over their lifetime to fulfill their lifetime giving goals, while still receiving the firsthand full income tax and estate tax benefits.

Some other difference with 401(k)s is that the program account can't be divided into multiple accounts for different beneficiaries, equally can be done with IRAs. If a client wishes to leave only a part of a large 401(k) to clemency, the segmentation has to be washed on the beneficiary designation form. If this becomes necessary, it is important to notation that, after death, the charity's portion of the 401(k) must be fully paid out by September 30 of the year following expiry, or else the non-charitable beneficiaries will lose the ability to stretch out their distributions over their lifetime if they are eligible designated beneficiaries equally defined by the SECURE Act..

Retirement plan assets like a 401(m) can be leveraged significantly to fulfill a client'due south charitable giving goals, since initial contributions reduce taxable income, earnings are tax-free, and distributions to a charity are tax-free while also providing a deduction for estate tax purposes. Every chat with a client about planned charitable giving should consider how to deploy these assets if possible. Information technology volition fulfill the common goal of maximizing the benefit to the charitable organization, while accruing tax savings to the client'south family unit.

At American Endowment Foundation, we expect forward to discussing how DAFs can play a role in edifice your AUM and aiding the charitable wishes of your clients. Contact us or phone call at i-888-660-4508 to learn more than.

_{Dawn Jinsky is a CPA, CFP® and a partner in Plante Moran'south Wealth Management group. She leads the firm's wealth transfer practice, which includes both the estate and business transition practise. With more than 20 years in wealth direction, she specializes in manor planning, wealth transfer, charitable planning, and assists family business owners with their transition plans. Dawn is a member of AEF's Council of Advisors.}

Source: https://www.aefonline.org/blog/leaving-401k-charity-what-advisors-need-know

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