Charitable gifts of retirement plan benefits.

When an individual dies, more than 75% of the total balance of his retirement plans (including profit-sharing plans, Sec. 401(k) plans, Sec. 403(b) plans, individual retirement accounts (IRAs) and defined benefit plans) could be eaten up in the form of taxes. These assets are potentially subject to the following taxes:

* Estate tax: The estate tax rates start at 37% for estates valued at over $600,000 and go up to 55% (plus an additional 5% tax on estates valued at over $10 million but not over $21.04 million).

* Income tax: When plan distributions are made to beneficiaries, the distributions are subject to income tax. The maximum Federal income tax rate is 39.6%. The beneficiaries are entitled to a deduction for any Federal estate tax attributable to such income.

* Excise tax: A 15% excise tax applies to a retirement accumulation that exceeds the amounts in aD of an individual's retirement plans over the present value of an annuity paid over the individual's life expectancy as of the date of death. The estate is allowed a deduction for the excise tax in computing the amount of the estate tax.

* Generation-skipping transfer (GST) tax: A flat 55% GST tax applies if a distribution from the retirement plan is part of a direct skip, taxable distribution or taxable termination.

When confronted with the possibility of giving more than 75% of their retirement plan assets to the government, individuals may want to consider naming a charity as a beneficiary of all or a portion of these benefits.

The advantage of naming a charity as the primary beneficiary is that the retirement plan interests will not be subject to estate or income taxes. However, the 15% excise tax on excess retirement accumulations will not be avoided and if the participant is married, the spouse must consent in writing to waive her rights to benefits under the retirement plans. (This requirement does not apply to IRAs.)

If an individual wants to name a charity as the beneficiary of only a portion of a retirement plan, that portion must be placed in a separate account by the earlier of the individual's date of death or the year the individual turns age 70 1/2 (the individual's required distribution beginning date). In the alternative, the individual may, prior to reaching age 70 1/2, roll over his retirement plan assets into separate IRAs, one earmarked for charity and one earmarked for the family

If the individual is married and is concerned about providing for his spouse's income needs should he predecease her, he could name his spouse as the primary beneficiary and a charity as the contingent beneficiary. The advantage of this technique is that the surviving spouse can roll over the retirement plan benefits into her own IRA, deferring the income tax until distributions are made. The 15% excise tax can be deferred until the surviving spouse's death, and no spousal waiver is required. The disadvantages are that the surviving spouse may choose not to name a charity as a beneficiary at her death (or at least not a charity preferred by her spouse). The surviving spouse may also choose to withdraw all the amounts in the retirement plan, leaving nothing for the charity.

If control by the spouse is a concern, an individual could name a qualified terminable interest property (QTIP) trust as the beneficiary. With a QTIP trust, the surviving spouse receives all the income from the trust during her lifetime. In addition, the trustee can make principal distributions to the surviving spouse should she need additional funds. On the surviving spouse's death, the remaining funds in the QTIP trust go to the charity. There will be no estate taxes using this technique. However, a spousal consent will be required and the 15% excise tax on excess retirement accumulations will apply.

If an individual is going to name a charity as a beneficiary, he should name the charity directly rather than naming his estate as the beneficiary and providing for the charity in his will or living trust. If the plan assets are paid to his estate, the estate will have taxable income without an offsetting charitable income tax deduction.

An individual cannot make a lifetime gift of retirement plan assets to a charity without paying income tax on the amount withdrawn. This may be an option, however, for individuals who are over age 59 1/2, in order to reduce retirement plan asset levels below the 15% excise tax level. For 1997, 1998 and 1999, the 15% excise tax on excess lifetime distributions (those exceeding $160,000 for 1997) is waived. (This waiver does not apply to the 15% excise tax due at death.) The income tax consequences of the lifetime distribution may be offset by the charitable contribution deduction. Keep in mind, however, that the phase-out of itemized deductions and personal exemptions for taxpayers above certain income levels (as well as percentage of adjusted gross income limitations) may reduce the amount of this deduction.

Conclusion

If an individual is concerned with the amount of estate, income, GST and excise taxes to be paid on retirement plan benefits at death, he should consider naming a charity as a beneficiary of all or a portion of the benefits. However, naming a charity as a beneficiary may cause larger minimum distributions during the individual's lifetime; the minimum distributions must be based only on the individual's life expectancy and not, for example, on the joint life expectancy of the individual and his spouse. Alternative sources of assets, such as life insurance, should also be considered for the individual's family, to make up for the fact that the family is not the beneficiary of the retirement plan assets. If life insurance is used, it is important to make sure that it will not be included in the individual's estate by using, for example, an irrevocable life insurance trust.