The SECURE Act of 2019 made dramatic changes to how inherited IRAs are handled. Previously, many non-spouse beneficiaries could “stretch” their distributions over a lifetime, spreading out tax liability for decades. Now, with some exceptions, most beneficiaries of inherited retirement accounts must be distributed within 10 years of the original owner’s passing. This accelerated timeline can cause unwanted – and sometimes substantial – tax consequences for beneficiaries, often pushing them into higher tax brackets
Fortunately, thoughtful estate planning – including charitable giving – may help you diffuse this “IRA tax bomb” and provide a meaningful legacy.
Why Naming a Charity Makes Sense
Assigning a charity as your IRA beneficiary allows the account to be emptied without triggering a large tax bill – the charity receives the entire amount tax-free, protecting heirs from potentially high-income taxes. However, careful planning is needed to avoid common mistakes:
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Name the Charity Directly
Listing the charity directly on your IRA beneficiary designation ensures that the funds are sent right to the charitable organization, bypassing probate and avoiding delays and expenses for your loved ones. The distribution to the charity is not considered taxable income to your estate or heirs, providing an efficient and generous legacy.
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Reverse Your Bequests
If you currently plan to support charities through your will, consider instead bequeathing retirement assets. Charities receive the same support, but your heirs benefit more; they avoid income tax on the retirement funds assigned to charities. Be sure to coordinate your will and beneficiary forms so charities are paid from retirement accounts, not double-dipped from both the estate and retirement plan.
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Set Up Separate IRA Accounts
When your intention is to benefit both individuals and charities, create separate IRA accounts for the charity and for your other heirs. If a charity is named as co-beneficiary on the same account as individuals, the payout period may be accelerated for living beneficiaries, increasing their tax burden. Separate accounts are a strategic way to minimize the impact of the IRA tax bomb and preserve the best possible tax treatment for everyone involved.
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Convert to a Roth IRA
Converting Traditional IRAs to Roth IRAs allows you to pay taxes ahead of time, enabling your heirs to inherit tax-free assets that continue to grow. However, avoid naming a charity as the beneficiary of a Roth IRA; since charities don’t pay income tax, converting to a Roth provides no additional estate tax benefit in this case.
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Beware of Trusts with Charitable Beneficiaries
A charity is classified as a “non-designated beneficiary” – it doesn’t have a life expectancy for distribution purposes. If a trust includes both charities and individuals as IRA beneficiaries, the living heirs may be forced to take distributions earlier than necessary, increasing their tax burden. Careful planning with an experienced estate advisor can help you avoid these unintended consequences and achieve your charitable goals.
Take Action – Protect Your Legacy
There are many ways to transform the threat of the IRA tax bomb into a meaningful benefit for your loved ones and charitable causes. For tailored advice, strategies, and personalized planning to defuse the IRA tax bomb, contact Boise Retirement Coach today. With over 30 years of experience, owner Peggy L. Farnworth, CPA, CFP, CSA, can help you build a retirement legacy that reflects both your financial goals and values.
**This content is being provided for educational purposes only and should not be construed as specific recommendations or investment advice. Always consult with your investment professional before making important investment decisions.
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Disclaimer
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Boise Retirement Coach and Cambridge are not affiliated.
