SI Parent Solves Taxing IRA Puzzle
Here's your estate-planning puzzle for the day.
Two people with identical estates leave the same size bequest to SI. One plan results in less tax than the other. Why?
An SI parent, who wishes to remain anonymous, has not only solve the puzzle but is using the solution to make a gift to SI at the least possible cost to his heirs.
He has seen his retirement plan grow tax-free over the years. But, wise in the ways of the law, he recognizes that he may simply be preparing a fatted calf for an IRS feast.
Unlike other estate assets, IRAs generate two taxes: estate tax at death and income tax payable by the recipients. He crunched the numbers and the results were appalling: his children would see about 30 percent of whatever remained of his retirement principal.
"I know others with the same problem," he said. The IRS wants the tax-free accumulation of wealth inside an IRA to provide for our retirement, not for our heirs. If IRA principal goes directly to heirs through an estate, the IRS takes a devastating double bite as it passes by.
But this bad news has a bright side. Since he plans to include SI in his estate plan anyway, what better asset to leave to the school than one that would otherwise be double-taxed to his heirs? SI will not have to pay the income tax due, and his estate will receive a deduction for the amount received. The other less tax-vulnerable assets will go to his heirs.
His IRA plan now states that 50 percent of what remains in his account goes to SI after he and his wife pass away. He expects that this will be the most tax-efficient gift he will ever make: his heirs are giving up only 30 cents on the dollar.
It will also be a relatively simple gift. He only had to change the beneficiary designation in his IRA plan. Other estate planning documents -- a will or living trust -- remain unchanged.
There are fancier solutions to the IRA riddle. Some donors provide that their IRA principle go to a testamentary charitable remainder trust with their hers receiving income from the trust. Because the IRA will not go directly to heirs, but be placed in a charitable trust for their benefit, the pension principal will bypass the income tax that would otherwise be immediately payable and generate some protection from estate tax.
But for now, this SI parent is satisfied with his simple and tax-efficient planned gift of 50 percent of his IRA to the school.
If all of this sounds complicated, think of this: Without this plan, about 70 percent of his IRA would have gone up in the smoke of estate and income taxes with other assets going to the school that might better have gone to his heirs. The complications were worth it -- to him, his family and SI.
A free, confidential analysis of the tax and income benefits of charitable trusts, including tax deductions and income flow projections, is available from the Development Office at SI.
If you are interested in learning more about how to use your IRA to help the school, contact Joe Vollert '84, Director of Development.
This story first appeared in Genesis IV, Summer 1996. Copyright St. Ignatius College Preparatory.