Gift Planning Tips

Providing for Both Spouse and Charity from an IRA or Other Retirement Account

IRAs and other retirement accounts can be ideal assets for testamentary charitable giving.  Naming charity as a death beneficiary avoids both income taxes (income in respect of a decedent) and federal estate taxes for estates subject to tax.  Charity keeps 100% of every dollar bequeathed, while other beneficiaries might lose as much as 60% to estate and state and federal income taxes.

Clients wishing to use a retirement account to benefit both a spouse and charity have several planning options:

  • Make charity a partial beneficiary of the account and leave the rest to the spouse, who would then rollover the benefits into his or her own IRA or receive distributions over his or her life expectancy under the general stretch-out rules for inherited accounts.

  • Leave part or all of the retirement account to a testamentary charitable remainder trust in which the spouse is the income beneficiary.  If the marital deduction is needed, the spouse must be the only income beneficiary [Code §2056(b)(8)].

  • Allow the spouse to disclaim part or all of an account to a charitable remainder trust that pays lifetime income to the spouse.

Ideally, where both spouses are committed to the same organization, the surviving spouse could be made the sole beneficiary of the IRA, with the expectation that he or she would leave part or all of the rollover IRA to the charity.  Of course, the first spouse to die has no absolute certainty that charity eventually will benefit under this strategy.


Interest Rate Traps for Annuity Trusts

The current low §7520 rates raise the possibility of disqualification of new charitable remainder annuity trusts, even those with modest payouts.  Annuity trusts must give rise to a minimum 10% charitable deduction (present value of the remainder interest) [Code §664(d)(1)(D)] and must pass the 5% probability test.  There cannot be more than a 5% possibility that the annuity trust will be exhausted before the trust terminates (Rev. Rul. 77-374, 1977-2 C.B. 329).  The 5% test does not apply to unitrusts or to annuity trusts for a term of years.  Here are the youngest ages under which a one-life annuity will pass the 5% probability test and 10% remainder test at various payout amounts, assuming a $100,000 contribution, quarterly payments and a 2% (October 2015) §7520 rate:

Payout amount

Youngest age

$5,000

72

  5,500

75

  6,000

79

  6,500

81

  7,000

82

  7,500

84

  8,000

86

Note that $5,000 is the minimum payout allowed under Code §664(d)(1)(A).  If a donor, age 80, were willing to limit payments to a term of no more than 10 years, the payout rate could be as much as 9.9% and still satisfy the 10% remainder test.



Two Remainder Gifts Worth Considering

Farmers, homeowners and trust beneficiaries all have “hidden” assets that may turn out to be the best choice for charitable contributions.

Remainder interest in a personal residence or farm [Code §170(f)(3)(B)(i)] — Perhaps the most attractive thing about giving a remainder interest in a personal residence or farm to charity is that, while carrying out their charitable intentions, donors need not change their style of living or that of their families.  Deductions are available without having to transfer the property to a charitable remainder trust.

Note that the gift must be of a remainder interest in the property itself, not in the proceeds of its sale.  Also, a gift of a remainder interest will not be effective as to any personal property (such as furnishings or equipment) included with the residence or farm.  Personal property should either be bequeathed outright to charity or to the surviving spouse for him or her to bequeath to charity, if desired.

Remainder interests in family trusts — A person who has been given a remainder interest in a trust may have an actuarially valuable property right that has relatively little value in the marketplace.  By giving the interest or an undivided portion of the entire interest [Code §170(f)(3)(B)(ii)] to charity, the client may be able to carry out charitable intentions and, at the same time, derive maximum current financial benefit from the remainder interest.

For example, a 55-year-old client owns a remainder interest in a trust created in her father’s will; her brother, age 65, was given the income interest for life.  Assuming the trust corpus is currently $1,000,000 and a 2% §7520 rate is used, the remainder interest is $714,110, based on the remainder factor of 0.71411 from Table S.  Depending on her own financial situation and that of her family, the remainderman may derive the greatest benefit from her remainder interest by giving all or a percentage of it to charity.  Her gift would produce an immediate income tax deduction, yet it would not involve any immediate out-of-pocket expenditures.


The Challenges of Trust Administration

Clients considering charitable remainder unitrusts sometimes hesitate to pay the fees charged by corporate fiduciaries, thinking they can serve as their own trustee.  But what exactly does the DIY client need to do?  In addition to making investment decisions that must balance the needs of the income and remainder beneficiaries, the client will be required to:

  • Value the trust assets every year so the unitrust amount (a fixed percentage of the trust assets) can be determined.  Valuation will involve fixing the fair market value of all investments on the date set out in the trust instrument.  Additionally, if the trust contains a hard-to-value asset such as real estate, a qualified appraisal will be needed to establish value (grantor/trustees are disqualified from this task under IRS regulations).

  • Make timely distributions of the unitrust amount, as called for in the trust instrument.

  • Track the income and capital gain realized by the trust, so that proper tax reporting can be made to the IRS and income beneficiaries.  The trustee takes the grantor’s cost basis as to assets transferred into the unitrust, and capital gains, when realized by the trust, may be passed through to the income beneficiaries under the four-tier tax reporting system [Reg. §1.664-1(d)(1)].

  • File annual tax returns for the trust, including Form 5227, Schedule K-1 of 5227 (to individual beneficiaries), Form 1041-A (if not all trust income is distributed in a particular year) and possibly other forms if the trust should become subject to private foundation taxes and penalties.  If appraisals were needed for any property transferred to the trust, such as real estate, collectibles or closely held stock, the trustee generally will be required to file Form 8282 reporting the details of the sale.

  • Clients serving as trustee often retain tax, legal and investment advisers to assist with these tasks, or might consider co-trusteeship with a commercial trustee.  In many cases, the charitable remainderman may offer trustee services at a modest cost.

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