How charitable bequests and beneficiary designations work

Key takeaway

A charitable bequest can transfer property by will, while a retirement plan beneficiary designation identifies the plan beneficiary. Review the will and the account designation together when planning a charitable gift.

The will and the retirement plan designation

Receiving a retirement plan interest under a will does not itself make someone a designated beneficiary for required distributions. The beneficiary must be identifiable under the plan designation, which can arise through an affirmative election or a default under the plan.

Beneficiary choice remains subject to applicable survivor benefit and domestic relations requirements. Ask the plan administrator for the current designation and the plan's beneficiary requirements.

Securities registered in beneficiary form

In Minnesota, for example, securities registered in beneficiary form pass at the last owner's death to beneficiaries who survive all owners. Other states differ.

Reregistration requires proof of all owners' deaths and compliance with the registering entity's requirements. Multiple surviving beneficiaries hold as tenants in common until division. If no beneficiary survives all owners, the security belongs to the sole owner's or last owner's estate.

If other estate assets are insufficient, the securities or proceeds remain exposed to debts, taxes, administration expenses and statutory allowances.

A recovery proceeding requires a written demand to the personal representative by a surviving spouse, creditor or someone acting for a minor dependent child. The proceeding must begin within two years after death.

The beneficiary can fully discharge this liability by transferring the still owned security or the net proceeds received from disposing of it to the personal representative. These rules do not promise a particular payment speed.

The charitable estate tax deduction

A qualifying charitable transfer can produce a federal estate tax deduction for a decedent who was a U.S. citizen or resident, if the transferred property is included in the gross estate.

A corporate recipient must be organized and operated exclusively for qualifying charitable purposes, with no private inurement, disqualifying lobbying or political campaign participation or intervention. Qualification depends on the recipient.

This deduction does not have the percentage ceilings that apply to individual income tax charitable deductions. It cannot exceed the transferred property's value included in the gross estate.

The particular interest is valued under applicable fair market value rules. Ordinarily, valuation occurs at death. An elected alternate valuation instead uses the dates and adjustments required by that method.

Death taxes payable from an otherwise deductible charitable bequest reduce its deduction, whether charged against the gift by the will or applicable law. This includes federal estate tax and estate, succession, legacy or inheritance taxes.

Only the bequest remaining after those taxes is deductible. Naming charity as the recipient of the residue does not itself free that gift from tax allocation.

Income tax when a charity receives an IRA distribution

Traditional IRA distributions enter the recipient's income to the extent required by the IRA rules, including the applicable exceptions. Basis from nondeductible contributions remains with an inherited traditional IRA.

A recipient qualifying for federal tax exemption generally has that exemption, but it can be denied under the applicable statutory rules. Unrelated business income and other specified taxes remain possible.

Do not assume every charity receives the full IRA value free of all tax. A payment to a beneficiary after death is distinct from a lifetime qualified charitable distribution.

Charitable payments from income

A nongrantor trust can deduct gross income paid to charity under its governing instrument. This concerns gross income, rather than merely a gift of principal.

An estate can also deduct qualifying gross income permanently set aside during the taxable year for a specified charitable purpose under its governing instrument.

Under both the instrument and the actual circumstances, the possibility of diversion from that purpose must be so remote as to be negligible. This estate set aside rule does not extend to every modern trust.

Fair market value. This is the price at which property would change hands between a willing buyer and willing seller, neither compelled to act and both reasonably informed about relevant facts.

Donor advised fund. This is a fund separately identified by a donor's contributions, owned and controlled by a sponsoring organization, where the donor has or expects advisory privileges over distributions or investments. Single organization funds and certain grant funds are excluded.

Four resources for your next step

Charitable planning records and questions checklist. Use this to prepare the charitable portion of your next advisor meeting. Keep your intended recipient and gift questions together as you review the will and account paperwork.
Retirement account records and questions checklist. Open this before contacting a plan administrator about a charitable beneficiary. Use it to organize the account records and questions you want the administrator to address.
How charitable remainder trusts work. Read this next if your charitable plans also involve payments to family members. It covers trust design beyond the outright gifts discussed here.
How charitable gifts of business and investment assets work. Open this when deciding whether to explore lifetime giving alongside a bequest. Bring questions about your particular business interest or investment holdings to that comparison.

A perspective on coordinating the team

"It's a mouthful, all to say that there's many, many more things to contemplate than just, you know, a tax return, right? There's there's there's elements of charitable giving, of estate planning, as was mentioned by the previous speaker. So it's a team sport. And, like any good team sport, it requires a quarterback."
From an Investor Advantage talk hosted by Richard C. Wilson

Common questions

Can a conditional charitable gift qualify for the estate tax deduction?

Yes, if the possibility that the transfer will fail is so remote as to be negligible when tested at death. The same test applies to a vested charitable interest that could later be defeated.

If someone has power to divert property to a nondeductible use, only the portion exempt from that power can qualify. This deduction rule does not establish enforceability or deductibility for wording naming a charity formed after death.

Is spousal consent required for a retirement plan election?

Yes, when the election is subject to the statutory survivor benefit waiver rules, unless the plan representative establishes a permitted reason consent cannot be obtained.

Consent must be written, acknowledge the election's effect and be witnessed by a plan representative or notary. Changing the designated beneficiary or benefit form requires further consent unless the spouse expressly permits changes without it.

Permitted reasons for missing consent include no spouse, an unlocatable spouse or another prescribed circumstance. Consent, or its permitted absence, applies only to that spouse. This is not a universal IRA consent rule.