Advanced Underwriting Consultants

Ask the Experts – May 21

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client wants to give 10% of his estate to his church when he dies. Should he simply change his will or is there something else he can do?

Answer: Your client could make an appointment to visit your attorney to draft a codicil stating, for example, that a percentage of his estate will pass to the church. Codicils are typically brief, but you should nevertheless have it drafted by your estate planning attorney to make sure everything is done correctly. Here’s an example:

I, [name], a resident of [county, state], declare that this is a codicil to my last will and testament, which is dated [date].

Whereas, I now desire to make certain changes to my last will and testament:

I give, devise, and bequeath to [the church] the sum of [amount to leave to the church], to be used for such purposes as the governing body may designate.

He could also direct how the money should be spent by the church, or specify a certain percentage of your estate that will pass to the church (as opposed to a lump sum).

Another way to leave a portion of his estate to the church is to name the church as the beneficiary (or partial beneficiary) of his IRA or other qualified plan. This is much quicker and easier than drafting a codicil because he only has to contact the IRA administrator to change the beneficiary. There’s also no charge to changing the beneficiary of your IRA, so he avoids attorney fees this way.

Possibly the greatest reason for leaving an IRA to the church as opposed to other property is to maximize heirs’ tax savings. When money is withdraw from an IRA, it is typically taxed as ordinary income to the person making the withdrawal. However, churches, as tax-exempt entities, wouldn’t pay taxes on IRA distributions, resulting in taxes never being paid on that income.

Here’s an example to illustrate the tax savings. Your client dies leaving an estate worth $1 million, which includes, among other assets, an IRA worth $100,000 and a bank account with $100,000 cash.

Your client wants to leave 90% of his estate to his son and the remaining 10% to the church. If he leaves the bank account, which is 10% of his estate, to the church, the church is $100,000 richer. While his son inherits $900,000, the IRA has a tax liability attached to it. Assuming his son’s marginal tax bracket is 25%, he would incur a $25,000 tax over time as he takes distributions from the IRA. Here’s the bottom line:

    • Church: $100,000
    • Son: $875,000
    • Federal Government: $25,000

If, on the other hand, your client designated the church as the beneficiary of his IRA, the church would still be $100,000 richer because it could cash out the IRA without incurring federal income taxes. Additionally, his son receives his full $900,000 inheritance without incurring any federal income taxes. Here’s the final score under this situation:

    • Church: $100,000
    • Son: $900,000
    • Federal Government: $0

Not only are the tax consequences better for your client’s son, but by leaving the church the IRA, your client saved his son from the trouble of dealing with the pesky required minimum distribution rules for inherited IRAs. In the first situation, regardless of whether the son wanted to withdraw funds from the IRA, he would be required to take a distribution based on his life expectancy. For example, if his life expectancy was 20 years from the date he received the IRA, he must withdraw a minimum of $5,000 ($100,000 divided by 20 years) in the first year that he owns the IRA.

When you die, you typically want to make things as easy as possible for your heirs, and send as little as possible to the government. Leaving an IRA to the church or other charitable organization is a simple way to achieve both of these results.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.