Excerpt from Retire Secure for Professors and TIAA Participants
Who Gets What? Maximizing Bequests to Charity and Children with Different Financial Needs
by James Lange, CPA/Attorney
The content of this article (with some edits) was originally published in an article I wrote for Forbes.com. Publishedwith permission from Forbes.com where Jim is a regular contributor.
An Obvious but Frequently Missed Drafting Error
After reading this chapter, you are likely to think—that is so obvious. How could I and my estate attorney both have missed this? Don’t feel bad. We have reviewed thousands of wills and trusts, and in our experience, hardly anyone gets this right. The mistake often costs families tens or hundreds of thousands of dollars or more.
I’m referring to the decisions that you make when you are crafting your estate plan and are trying to figure out Who Gets What. In this chapter, I want to focus on the smartest solution for donations or inheritances that you leave to a charity and children with different needs after you and your spouse pass.
There are several critical ideas to cover, but the most fundamental is: what are the tax implications to each recipient if they inherit your money? By being very selective about who receives which type of money, you can dramatically cut the share that goes to the IRS and increase the amount going to your family or your favorite charity.
A tax-exempt charity does not care in what form they receive an inheritance. They never have to pay taxes on the money they receive. To them, a dollar is a dollar. Your heirs are tax-paying entities, and it makes a huge difference what type of assets they inherit.
So, if you want to leave $100,000 (or any significant amount) of money to a charity, do it through the beneficiary designation of your IRA or retirement plan, not your will or revocable trust. This is a simple tweak to your estate plan that can be very beneficial to your heirs.
What if My Children Have Different Needs?
The different income tax brackets of your beneficiaries may create an opportunity for tax savings by simply changing who gets what. For example, imagine you have two adult children, and one child is in the 32% tax bracket and the other in the 12% bracket.
Let’s keep it simple and assume you have a $1 million Roth IRA and a $1.4 million Traditional IRA. The status quo is each child will receive 50% of both assets. If you forget growth, each child will get $500,000 Roth IRA and $700,000 Traditional IRA. The IRS will get $308,000 which represents the taxes both kids will have to pay on the inherited Traditional IRA ($700,000 times 12% = $84,000, and $700,000 times 32% = $224,000).
Let’s assume instead you leave the $1 million Roth IRA to the child in the 32% bracket and the $1.4 million Traditional IRA to the child in the 12% bracket. The IRS would only get $168,000 in taxes. This means your children would get an extra $140,000 worth of purchasing power, which is the difference between the amount paid to the IRS in the two scenarios. In addition, since hopefully, your children aren’t planning on blowing their inheritance the year that you die, the extra $140,000 will continue to grow after you die.