There are multiple ways to leave a positive impact at the end of your life. One of these is through bequests to charities that are meaningful to you — but bequests can also take multiple forms. Other than the option to leave a charitable bequest in your will, you may want to consider leaving a charitable bequest in your retirement account. This method has significant tax benefits, which can positively affect both the loved ones you leave assets to and charities you choose to leave bequests to.
What are the advantages of bequests in a retirement account?
First, a charity doesn’t have to pay income taxes on a retirement plan’s distribution, which means funds from an IRA or 401(k) will have a greater impact when received by the charity.
On the flip side, if your IRA is left to family or loved ones, it’s up for significant taxation. A traditional IRA account is subject to high federal income taxes, and potentially state income taxes. These add up quickly and can be as high as 40% for federal, and 20% for state.
Leaving your charitable bequests through your retirement account also frees up the rest of your estate for the loved ones you designate as beneficiaries, resulting in more after-tax cash for them.
Does anything change based on what retirement account I have?
In some senses, yes. If you have a traditional IRA, a 401(k), or a 403(b), all of the above benefits apply.
But, if you have a Roth IRA, it’s not as tax-smart to leave your charitable bequests from that account. As long as your Roth IRA has been open for five years prior to your heirs making withdrawals, they’ll receive that money tax-free. Choosing charities as beneficiaries instead means your heirs lose that valuable tax break. In this case, you may be better off designating your charitable beneficiaries directly in your will.
How do I implement this?
It’s actually pretty simple to designate charities as beneficiaries in your retirement account. Get the Beneficiary Designation Form for your IRA or 401(k), and designate either a dollar amount or percentage to the charities of your choice. You can change this in the future just by updating the form.
With a management company like Vanguard, you can find this online under “Forms.” Just select “Complete Online” next to IRA Beneficiary Designation:
If you know you’d like to leave a charitable bequest but you haven’t decided on the specific organization, you can use a Donor Advised Fund. This also allows your loved ones to make gifts in your honor if you have not otherwise designated where the funds should be directed.
Of course, as with any decisions of this nature, you’ll want to consider the pros and cons in the context of your specific estate. But generally speaking, strategically designating a charitable bequest in your retirement account can have huge tax benefits for both the charity and your heirs, allowing you to maximize your impact on the people and causes you care about.