When setting up planned gifts to charities, the primary source of those gifts should be your IRA or 401K. If an IRA or 401K is left to a charity, the charity will likely distribute the IRA to itself in the first year after your passing. Assuming the charity is a tax-exempt organization, the charity will not owe income taxes on the distribution.
Alternatively, if you leave your IRA or 401K to an individual other than your spouse or minor child, that individual (with a few exceptions) will be required to distribute the IRA to him/herself within 10 years of your passing. When those distributions are made, that individual will pay income tax on all the distributions.
Under current law, if you leave that same individual your non-retirement assets in your will or revocable living trust, the individual will receive those assets with no negative income tax consequences. In fact, they will most likely receive the assets with a stepped-up basis to the fair market value on your date of death. This step up in basis means that even if the asset appreciated significantly during your lifetime, the recipient of the asset can sell the asset with little or no capital gains.
Imagine an estate of $10 million after paying estate taxes and estate expenses. The estate has $5 million in IRAs and 401Ks, and $5 million in non-retirement assets. If the estate is split evenly between charities and individuals, the charities will net $5 million regardless of whether they receive retirement assets or non-retirement assets. The individual, however, will be much better off if they receive the non-retirement assets. If they receive retirement assets, their net proceeds will be reduced by the income taxes owed on the distributions. If they receive non-retirement assets, however, they will receive those assets with a stepped-up basis under current law. With the stepped-basis, the recipient can liquidate those assets immediately after receiving them for no gain. Therefore, when the recipient receives non-retirement assets, the net value of what they receive is the $5 million received, not reduced by any income taxes.
In most cases, the numbers do not work out as perfectly as the above example. Therefore, we can add language to your will or revocable living trust to increase or decrease amounts going to charities through those documents based on the amounts the charities receive under your retirement assets.
If you would like to discuss your planned giving goals, please let us know.