October 28, 2019
By Doug Olson, senior vice president of Thompson & Associates
The Sanford Health Foundation partners with Thompson & Associates to provide donors with complimentary values-based estate planning services.
Since their inception, Individual Retirement Accounts (IRAs) and other qualified pension plans have become popular means of building wealth to provide income during retirement. Today, billions of dollars of assets are owned through these tax-advantaged savings vehicles.
Even with the minimum distribution rules for mandatory withdrawal (required minimum distributions — or RMDs — begin at age 70 ½), many of these plans will still have large balances at the death of the owner or surviving spouse.
A tax trap for family
If the largest asset in your estate is your retirement plan, you may be surprised to learn that these tax-advantaged savings vehicles can become tax traps when you direct any balance to a non-spouse beneficiary.
Income taxes embedded in retirement assets are over and above the estate tax that will be calculated for all assets in your total estate.
Generally, the undistributed balance of qualified retirement plans is fully includable in your gross estate for estate tax purposes. Since the funds in retirement accounts usually represent income that has not been subject to income tax, giving the accounts to individual heirs exposes the funds to significant income taxes.
Your retirement dollars can be seriously depleted by this double taxation.
It is common for individuals to assign contingent benefit of retirement assets, after a spouse, to their children. It would appear to be a natural and generous thing to do.
However, the reality of such transfers is often a dramatic shrinkage of the account balance, as nearly 70 percent of heirs opt to take the lump sum available (rather than a stretch-out) and pay whatever income tax is due.
The double tax consequence for retirement accounts, when estate taxes are combined with income taxes, can be very unfavorable. The range varies by estate size, but as much as 60 to 75 percent of retirement assets can be lost in this double tax trap.
The best asset to give away
Because of these tax realities, retirement accounts become the first place to look as a “giving pocket” for families who have identified some level of charitable intent for their estate plan. With the taxes that can be saved in giving away some or all of these highly taxed assets, it actually makes the cost of giving less than in giving other assets.
Furthermore, with the higher federal estate tax exclusion levels seen recently, more and more estates are not subject to federal estate tax. For families, this means that with proper planning, all or most non-retirement assets may often be passed on to heirs without tax consequence. That leaves retirement accounts, for many families, as the major tax concern.
For those with interest in directing social capital dollars to charities of choice, rather than to Uncle Sam, retirement accounts become the ideal pocket for giving.
“We feel like we’ve paid a lot of taxes throughout our lifetime — always paying what we owe — and thought there would also be tax obligations for the heirs of our estate,” said Tom and Kathrine Schnabel of Sioux Falls, who made a commitment to the Sanford Health Foundation through their estate plan. “We were very pleased that Doug Olson provided us with options to legitimately leave more to our heirs and charities and less to taxes.”
For more information about maximizing your estate, please contact Amy Bruns, lead major gift officer at the Sanford Health Foundation, at firstname.lastname@example.org or (605) 312-6742.