How to Name a Charity as an IRA Beneficiary

Leave it to the tax code to turn something easy into something complicated.One would think that naming a charity as the beneficiary of an IRA would be an easy thing. Name the charity as the IRA’s beneficiary or as one of the co-beneficiaries. It is as simple as that, right? Wrong.

If you name the charity as a direct beneficiary of the IRA, when it comes time for the charity to receive the contribution, the IRA custodian must create all kinds of obstacles and paper-work. Most IRA custodians will require the charity to open its own account with the custodian or go through a process similar to opening an account.The problem is that financial services firms have to comply with the “know your client” rule under the Patriot Act.

The charity has to provide the custodian with a lot of information about not only the charity but also its directors and maybe some key employees. That’s a lot to ask of a charity, especially if the contribution from the IRA isn’t substantial.

A few large charities might have gone through the process often enough that it’s a somewhat routine process for them, but you can’t count on it. The better method, which is recommended by most IRA custodians, is to first create a donor-advised fund (DAF) account at one of the major sponsors of donor-advised funds.

Most major brokers and mutual funds now offer these accounts. Community foundations and some localities and other charitable institutions also sponsor DAFs. You can read more about DAFs in our May 2019 issue.Then, you name the DAF account as the IRA beneficiary. After your death, the IRA distributes the appropriate amount of money to the DAF, which contributes the money to the charity. The DAFs are in the middle of these transactions.

So, it is easy for them to take the distribution from the IRA and transfer it to the charity or charities you want to receive it.Another step in the process is deciding how much to leave the charity and how to allocate the IRA to it.One option is to create a separate IRA of which the charity or the DAF is the sole beneficiary. Move some money from your main IRA into the IRA for the charity. The charity then receives the entire IRA after you pass. There are no questions about how much the charity will receive.

Another option is to name the charity as one of several co-beneficiaries of an IRA, along with your children or other beneficiaries of your choice. If you do that, you need to be precise about designating how much will go to the charity and be sure the result under different circumstances is what you intend. For example, you might have an IRA with $500,000 in it and decide a charity should receive $50,000 of it, with the rest going to your children. You believe that $450,000 from your IRA, plus the rest of your estate, is the amount you want the children to inherit.But what if the markets decline sharply shortly before your death and you haven’t changed the beneficiary instructions? Let’s say the IRA is down to $300,000. The charity still receives $50,000, and your children receive only $250,000.

Or suppose the IRA’s investments do well and it is worth $750,000. Would you still want the charity to receive only $50,000? Or should it receive $75,000? Or some other amount?When a charity is one of several co-beneficiaries, you probably want the beneficiary designation to be a conditional statement.You probably do not want to say, “The DAF is to receive 10% of the IRA, based on its value on the date of my death.”

That doesn’t account for fluctuations in the IRA’s value. An alternative is, “The DAF is to receive 10% of the IRA, based on the val-ue on the date of my death, or $60,000, whichever is less.”To protect your beneficiaries you might state, “The DAF is to receive 10% of the IRA, based on the value on the date of my death, provided the IRA’s value is at least $500,000. If the value is less than $500,000, the DAF is to receive nothing.”

As with other estate planning actions, the key is to contemplate different scenarios and decide the result you want in each. Don’t make the mistake of considering only today’s circumstances and writing that into your estate plan. When you intend to leave part of your estate to a charity, the best way to make that bequest often is through your IRAs.When your children or other beneficiaries inherit a traditional IRA, they pay taxes on the distributions just as you would have. They inherit only the after-tax amount. But when a charity inherits part of an IRA, it owes no taxes when the amount is distributed to it.

When your children inherit investments outside of an IRA, the children get to increase the basis of the assets to their fair market values on the date of your death. No capital gains taxes are owed on the appreciation that occurred during your lifetime. They also do not owe taxes on most other assets they inherit.

The lesson is to make any charitable bequests through an IRA or other qualified retirement account. Maximize the amount your children inherit outside of an IRA.