Naming a charity as beneficiary of retirement plan assets.

Estate plans that intend to include charitable donations should consider transferring account balances of qualified retirement plans or of individual retirement accounts (IRAs) to a charity of choice. This planning strategy enables the estate to take a charitable deduction as well as escape income tax. Designating a charity as the beneficiary of an IRA or a retirement plan can minimize both estate and income taxes while allowing a transfer of other assets to noncharitable heirs. Another strategy is to use a charitable remainder unitrust (CRUT). With a CRUT, the spouse can receive the income from a retirement plan or IRA while passing the principal to the charity free of estate tax. This also minimizes the income tax impact and the spouse is taxed only as the unitrust amount is paid annually. It is also possible to designate someone other than the spouse as the income beneficiary, but the estate tax deduction is reduced accordingly.

Normally, amounts received as a beneficiary of an IRA or a retirement plan are income in respect of a decedent (IRD) under Sec. 691 and are therefore included in the recipient's gross income when received. However, Sec. 2055 allows a charitable deduction for estate tax purposes when the complete interest in property is transferred to a governmental entity or to a charity exclusively for religious, charitable, scientific, literary or educational purposes.

A simple estate planning technique is to designate a charity as beneficiary of the IRA or retirement plan (spousal consent is required for such a designation from most qualified plans). The estate receives a charitable deduction while the charity is not taxed on the amounts received from the IRA or qualified plan (since it is not unrelated trade or business income).

A more complex plan would involve naming a CRUT as the beneficiary of the IRA or retirement plan. CRUTs, as described in Sec. 664, allow a charitable deduction for the present value of the remainder interest. The trust term cannot be longer than 20 years or, if less, the life of the income beneficiary. In a unitrust, the income beneficiary must receive at least annually the sum of --the lesser of a percentage of the net fair market value of trust assets on the annual valuation date (but not less than 5%), or the trust income for the tax year; and --the trust income for the tax year in excess of the unitrust amount for such year, to the extent the aggregate amounts actually paid in prior years are less than the aggregate unitrust amounts for all prior years.

In no event would more than the aggregate trust income be paid. A charitable remainder trust itself is not subject to income tax except to the extent it has unrelated business income. The income beneficiary of a unitrust is taxed on the trust's distributions. The distributions have the following character, in order, to the extent there is such income in the trust (either for the current year or undistributed from prior years): ordinary income, capital gains, other income, and distribution of principal.

Two IRS letter rulings support the charitable deduction of the present value of the remainder interest in an IRA or a retirement plan account contributed to a CRUT for estate tax purposes. In Letter Ruling 9237020, the settlor of the trust also had an IRA whose named beneficiary was the trustee of a CRUT. The trust's income beneficiary was her son. The present value of the property transferred to the CRUT on the settlor's death qualified for the estate tax charitable deduction. Further, this ruling described the income tax consequences of the IRA because it remained IRD: The trust would not be taxed on its income unless it had unrelated business income; the character of the amounts paid from the CRUT to the income beneficiary remained the same as under the general rule.

In similar circumstances, the settlor in Letter Ruling 9253038 was a participant in a retirement plan qualified under Sec. 401 (a). The settlor was the CRUT's income beneficiary during his life; after his death his wife becomes the income beneficiary. Under the terms of the retirement plan, if a participant dies before his account balance is distributed, his beneficiary will be entitled to the full value of his account. Here, the settlor designated the CRUT as beneficiary of a portion of his retirement plan account that would be distributed to the trust in a lump-sum payment, or in any event within a year or two. The wife was the beneficiary of the remaining portion of the retirement plan.

The amounts of the retirement plan account going to both beneficiaries were deductible from the estate: the wife's portion as part of the unlimited marital deduction and the CRUT's portion as a charitable transfer. Generally, the marital deduction is not allowable in the case of a life estate or other terminable interest; however, if the surviving spouse is the only noncharitable beneficiary of a qualified charitable remainder trust, the present value of the wife's interest in property passing from the plan to the trust as a result of the husband's death will qualify for the estate tax marital deduction. Sec. 2056(b)(8) specifically provides that a remainder interest is deductible for the estate tax charitable deduction if such interest is in a qualified charitable remainder annuity trust or a CRUT.