If you’re lucky enough to be in a position such that you’re financially prepared for retirement, you might have the capacity to make some provisions for your heirs or your favorite charity through your individual retirement account.
“When people of wealth accumulate a lot of assets, the IRA is a tool they can use in many different ways,” says Carolyn Rogers, senior vice president and wealth services adviser at The Sanibel Captiva Trust Company. “If you’re not going to need the money from the IRA, there are other things you can do with it.” One option is to designate heirs or a nonprofit organization as the beneficiary of the IRA. This means they would receive the benefits of the IRA after the account holder dies.
When leaving an IRA to heirs, there are a few things to consider. The passage of the SECURE Act of 2019 eliminated the ability for beneficiaries to stretch out their distributions over their lifetime. Now, most beneficiaries who are not the surviving spouse must withdraw the assets from the inherited IRA within 10 years of the account holder’s death. “There are stiff penalties if you don’t do it properly within a certain timeframe,” says Rogers. “It’s really important that people know the rules around their retirement account.”
Heirs are also subject to taxation on the inherited IRA funds, which will now happen in a more concentrated time period. “Traditional IRAs, subject to exceptions, are going to be fully taxed to non-charity heirs,” says Jennifer Figurelli, co-founder and managing director of Andrew Hill Investment Advisors in Naples. (There are some other options, such as setting up a trust, that a financial adviser or estate planning attorney could discuss with clients.)
A nonprofit beneficiary, on the other hand, would not have to worry about paying any taxes. “What [the SECURE Act] has done is give individuals an opportunity to select a charity to be the beneficiary,” says Figurelli. “A charity recognized by the IRS as being tax-exempt doesn’t care in what form they receive an inheritance; they never have to pay taxes on the money.”
There’s also another option for charitable giving through an IRA. Starting at age 72, investors must take a required minimum distribution every year from traditional IRA accounts and other retirement savings accounts. Account holders must take these funds by Dec. 31 or face a 50% penalty. But up to $100,000 from an RMD can be gifted to a qualified charity each year, and the account holder won’t have to pay taxes on that money.
“When you take the required minimum distribution, you’re taxed at your current income level,” says Rogers. “If IRA owners’ tax rates are high, it may make better sense for them to take that RMD and have it go straight from their investment account to a qualified charity so they don’t take on any tax burden.”
Rogers advises nonprofits to seize these kinds of opportunities. “I would try to guide people who work in the nonprofit sector, when going after significant gifts, to not think about just what’s in [a donor’s] current checkbook,” she says. “It’s really smart for nonprofits to approach their prospective or current donors and remind them, ‘Hey, how about your RMD? Did you know that you can make contributions out of your IRA that won’t have any tax implications to you?’ It’s really a win-win for donors as well as charities.”
From the legal department
Another end-of-year option to consider? Setting up a custodial Roth IRA as a holiday gift for a child or grandchild. But there are a few things to keep in mind.
The main thing is that the child or grandchild must have an earned income in order for contributions to be made to the account. An allowance doesn’t count as earned income. But if a teenager has a job at, say, Publix or Starbucks, a parent or grandparent could make a contribution to a custodial Roth IRA that doesn’t exceed the child’s earned income for the year. Earned income can also come from lawn mowing, dog walking, baby-sitting or other jobs that a teen performs for people outside of their family, but it requires a little record-keeping. (Ask your financial adviser for guidance.) For 2021, the max amount that a parent or grandparent could contribute to a custodial Roth IRA is the lesser of $6,000 or the child’s earnings for the year.
A custodial Roth IRA can be a great way for grandparents with some extra cash to support their grandchild’s future, and that grandchild won’t have to pay taxes on the money in the Roth IRA when they access it down the road. “It could be really helpful to kickstart retirement planning for a grandchild,” says Sanibel Captiva Trust Company’s Rogers.