More than $4 trillion has accumulated in the individual retirement accounts (IRAs) of Americans, even with the downturn in the stock market after 2007. IRAs clearly play an important role in the financial lives of millions of workers and retirees, and we have prepared this booklet to describe some of the planning possibilities available to IRA participants. We will also discuss why your IRA might be the ideal estate planning tool for assisting Catholic Charities of Baltimore. Additionally, for friends who are past the age of 70½, Congress has renewed a special opportunity for IRA giving through the end of 2011. We have heard from many friends in the past that they would like to consider important contributions, but that their best resource for giving an IRA was off limits. In recent years, those limits have been removed for donors past the age of 70½ who make contributions in a prescribed manner. We encourage you to contact our office if you are interested in contributions through your IRA. Inside This Guide Book Make the Most of Your IRA......... 2 Traditional IRAs................... 2 Roth IRAs......................... 4 Spousal and Rollovers IRAs......... 5 IRAs in Your Estate Planning........ 5 IRAs: Your Best Charitable Bequest.... 6 Options for Arranging IRA Bequests.... 7 M-IRA-culous Gift Opportunity......... 9 Gift Ideas with Your IRA............. 10 IRA Gift Rule Book.................. 11 A Final Word....................... 11 Notes for Tax Advisers................ 11 1
Make the Most of Your IRA An IRA is a personal retirement savings plan available to all Americans who have taxable compensation. To be able to deduct IRA contributions, workers must have income in the form of wages, salaries, commissions, fees, bonuses or tips. IRAs also enable tax-free accumulation of income on contributed funds. IRAs are splendid savings and financial tools, but the rules can be complex and it is important to seek out competent advice in at least four circumstances: n When you leave a company where you participated in a qualified retirement plan. Too often, employees depart with checks representing their savings in the company s plan all of which is immediately taxable and possibly subject to a 10% penalty for early withdrawal. Rolling over these funds to an IRA would have postponed the tax, avoided any penalty and kept in place the opportunity for taxdeferred growth of savings. n When you select investments for your IRA. Mutual funds and investment advisers often recommend retirement portfolios specific to a person s age, risk tolerance and anticipated retirement date, if still employed. n When you inherit an IRA from a spouse or other person. If your benefactor has planned wisely, you may be able to stretch IRA distributions over your life expectancy and preserve a tax-deferred account for many years. Where more than one IRA beneficiary is named, some beneficiaries may be well-advised to cash out or disclaim benefits. n When you are planning your estate. IRA funds are heavily taxed in one s estate, but several plans are available often including charitable giving that can minimize taxes, provide investment management and leave family members financially secure. Many varieties of IRAs have come into being over the years. This booklet will concentrate on traditional IRAs, Roth IRAs, spousal IRAs, rollover IRAs and inherited IRAs. TRADITIONAL IRAS Traditional IRAs permit employed and selfemployed persons and non-working spouses to make contributions, generally up to $5,000 a year. Workers age 50 and older may make additional catch-up contributions of $1,000 annually. 1 Earnings on these savings accumulate tax free, and income tax deductions are available for workers not covered by employer retirement plans. 2
Withdrawals must start when owners reach the age of 70½; otherwise, a 50% penalty will be owed on amounts not withdrawn. With a few exceptions, removing funds from an IRA before age 59½ will result in a 10% early withdrawal penalty. 2 Financial planners generally suggest holding investments that produce income that is favorably taxed tax-exempt bonds, long-term capital gains and qualified dividends outside IRAs, since IRA distributions (other than from Roth IRAs) are typically taxed as ordinary income (at your highest tax rate). An IRA is a good place for investments that generate interest and other fully taxed income, such as corporate bonds and real estate investment trusts (REITs). As noted, traditional IRA owners are required to begin withdrawing funds after attaining the age of 70½, or they will face substantial penalties. Technically, the first required distribution need not be taken until April 1 the year after turning 70½. However, waiting will mean taking distributions for both the prior year and the current year and the double distributions could push you into a higher tax bracket. At the end of each year, owners must calculate the value of their IRAs and then divide that amount by the applicable distribution period (the owner s remaining life expectancy plus 10 years, according to the IRS). The following is a table of applicable distribution periods for account owners of different ages. 3 A more favorable table applies where a spouse, who is more than 10 years younger than the account owner, is named as survivor beneficiary of the IRA. Note that taxpayers benefit from a revised life expectancy every year, so that it s difficult to exhaust the account. We ve also illustrated the required annual distributions as percentages. Distribution Minimum % Age Period to Withdraw 70 27.4 3.6496% 71 26.5 3.7736 72 25.6 3.9063 73 24.7 4.0486 74 23.8 4.2017 75 22.9 4.3668 76 22.0 4.5455 77 21.2 4.7170 78 20.3 4.9261 79 19.5 5.1282 80 18.7 5.3476 81 17.9 5.5866 82 17.1 6.8480 3
Distribution Minimum % Age Period to Withdraw 83 16.3 6.1347% 84 15.5 6.4516 85 14.8 6.7568 86 14.1 7.0922 87 13.4 7.4627 88 12.7 7.8740 89 12.0 8.3333 90 11.4 8.7719 91 10.8 9.2593 92 10.2 9.8039 93 9.6 10.4167 94 9.1 10.9890 95 8.6 11.6279 96 8.1 12.3457 97 8.1 12.3457 98 7.1 14.0845 99 6.7 14.9254 To illustrate, a participant would calculate minimum withdrawals from a $1 million IRA at age 71 by dividing $1 million by 26.5 ($37,736). The following year, if the value of the account remained at $1 million, the account owner, now age 72, would divide by 25.6, taking out a minimum $39,063 payment. ROTH IRAS Roth IRAs allow workers to make nondeductible contributions that can later be withdrawn tax free, along with accumulated earnings. Withdrawals will not be taxed if the funds remain in the account for more than five years and are made after age 59½ or to pay for educational expenses. 4 Roth IRAs, unlike traditional IRAs, have no required age after which payments must start. If you plan to let the account grow and eventually pass to children or grandchildren, the Roth IRA may be the better tax-planning tool. Death benefits from a traditional IRA are subject to both income tax and estate tax, while the Roth IRA is subject only to estate taxes. Congress formerly allowed owners of traditional IRAs to convert their accounts to Roth IRAs only if their modified adjusted gross income was below $100,000. 5 An inherited IRA cannot be converted to a Roth IRA. Now, all IRA owners, including those with incomes of more than $100,000, are able to convert to Roth IRAs by paying tax on funds accumulated in their traditional IRAs. Taxes on conversions made in 2010 can be stretched over the following two years (50% is taxed in 2011 and 50% in 2012), unless the taxpayer elects otherwise. A donor who converted to a Roth IRA in 2010 may want to make charitable contributions to help offset the resulting tax bill in 2011 and 2012. Outright gifts of cash, appreciated securities or other assets will generate large deductions, but donors also might want to consider establishing charitable remainder 4
Spousal IRAs allow a husband or wife to make contributions to the IRA (traditional or Roth) of a spouse who has insufficient compensation to make the maximum allowable contribution to an IRA. The spouses are required to file a joint tax return in the year a contribution is made. Rollover IRAs can be set up by individuals to receive distributions from a qualified retirement plan upon their termination of employment or retirement. The rollover IRA allows further tax deferral, and no withdrawals are required until the year after you reach age 70½. At that point, any amounts withdrawn are taxed as ordinary income. Note: To avoid 20% withholding on your retirement funds, have the trustee of the retirement plan transfer the funds directly to the custodian of your rollover IRA (a trustee-to-trustee transfer). Surviving spouses may establish rollover IRAs from the IRA or qualified retirement plan of a deceased spouse and treat the new IRA in the same fashion as if he or she had set up the IRA while working. 6 trusts, charitable lead trusts or deferred payment charitable gift annuities during these years, or transferring a personal residence (including vacation homes) or farm property, while retaining lifetime use or occupancy. SPOUSAL AND ROLLOVER IRAS IRAS IN YOUR ESTATE PLANNING IRAs present significant estate planning challenges. Whom should I name as beneficiary? Will that person (or persons) be up to the task of investing and managing a large sum of money? What will happen to the IRA funds after my beneficiary dies? Is there a way to preserve the IRA intact for a long period of time so it can grow tax-deferred? How much of the IRA will be lost to income taxes or state and federal death taxes? As noted at the beginning of this booklet, it makes sense to get the advice of an experienced professional in addressing all these questions. Married IRA owners commonly leave their qualified retirement accounts or IRAs to surviving spouses, who roll over the funds into new IRAs, which allows the accounts to qualify for the estate tax marital deduction. Surviving spouses essentially can treat rollover IRAs the same as IRAs they might have set up independently. At the surviving spouse s death, the rollover IRA 5
can pass to the couple s children and become a stretch IRA, continuing taxdeferral for many more years. In second marriage situations, however, the IRA owner may worry that any children from a prior marriage could be disinherited when the surviving spouse who is not the children s parent passes away. One solution is to make the IRA beneficiary a so-called QTIP trust, which will pay the surviving spouse lifetime income and still qualify for the estate tax marital deduction. The IRA owner can designate children from a prior marriage to eventually receive the trust assets. But employing a QTIP trust may result in more rapid distributions from the IRA, reducing the amount ultimately passing to heirs. IRA owners who wish to leave account balances to children or others can simply name them as beneficiaries on forms provided by the account custodian. Heirs could then divide the IRA into separate accounts and take distributions stretched over their individual life expectancies preserving the advantages of tax-deferral. What if the IRA owner worries that children or grandchildren may choose to take IRA benefits in a lump sum (with unfortunate tax results)? With careful planning, a lookthrough trust can be arranged to preserve the stretch IRA advantages and provide money management to beneficiaries. Remember that look-through trusts must meet a number of technical requirements you ll need the help of a professional. IRAS: YOUR BEST CHARITABLE BEQUEST Estate planning advisers have been telling clients for many years that IRAs are the very best thing to leave to charitable organizations in their estate plans. A combination of death taxes, income taxes and Harold s Estate ($1,000,000 total estate) Erosion from Taxes of Retirement Accounts 8 Total Federal/State Remaining Income Taxes Estate Taxes for Heirs $100,000 IRA $ 38,250 None $61,750 passes to children (62% of $100,000 IRA) Sarah s Estate (2011 death) ($7 million $343,000 FET $374,550 (37%) taxable estate) + 20,000 State from original $1 million IRA $262,450 $363,000 total $1 million IRA passes to child 6
even generation-skipping transfer tax can nearly confiscate the retirement accounts of many people at death, leaving little remaining for heirs. n State and Federal Death Taxes. The full, date-of-death value of retirement savings may be subject to federal estate tax, and many states impose inheritance or estate taxes as well. n State and Federal Income Taxes. Both federal income tax and state income tax (depending on the place of residence of your heirs) will be due on death benefits from an IRA or other plan costing as much as 40% or more. Most bequests and inheritances come to heirs free of income tax but retirement benefits (except for Roth IRAs) are fully taxed to your heirs or estate. Many of these taxes can be postponed when retirement assets pass to a surviving spouse who then establishes a rollover IRA. But an expensive visit from the tax collector costing up to 60% or more lies ahead, for married and unmarried people alike, when retirement savings pass to other relatives. The examples in the chart on page 6 show shrinkage that can occur for both small and large estates. A more satisfying option might be to leave the retirement account to support our programs and preserve all of the funds free from tax. 7 It s easy to leave part or all of your IRA for our benefit. Simply ask the custodian of your account for a beneficiary designation form. We will be glad to provide you or your advisers with our correct legal name. We can also be named as a beneficiary of qualified retirement plans such as a 401(k), although married donors will need their spouses consent. The example of Harold s estate assumes children are in a 35% federal income tax bracket and a 5% state income tax bracket. The example of Sarah s estate assumes a 35% estate tax rate, and that heirs will be in a 35% federal income tax bracket and a 5% state income tax bracket (state income taxes and federal estate taxes are deductible against federal income tax). Total state death tax is $50,000 on her $7 million estate, including $20,000 on the IRA. Results of a charitable bequest? All taxes on these IRA assets would be avoided, meaning significant benefit to our programs at little cost to heirs. Substantial tax savings also would occur if retirement assets were left to a charitable remainder trust from which income is paid to heirs for life or a term of years. OPTIONS FOR ARRANGING IRA BEQUESTS Beneficiary Change. Instruct the custodian of the retirement account to name us as partial or 100% death beneficiary. The custodian can provide the appropriate forms. As discussed below, the account can be left partially for our benefit with the rest passing 7
to a spouse or family members. Will or Living Trust. If no death beneficiary is named for an account (which is rare), a will or living trust can provide that retirement assets are specifically designated to pass for our benefit (or as part of the residue of your estate if we are the sole residuary beneficiary). 9 Trusts for Spouses. You could set up a charitable remainder unitrust today for you and your spouse and fund the trust initially with cash or stocks. You would make your IRA or other retirement account payable at death to the unitrust, providing security for your surviving spouse and completely avoiding federal estate taxes. Alternatively, you could simply establish a charitable remainder trust for your spouse in your will and change your IRA beneficiary designation to the trust. 10 Trusts for Children and Others. You can change the beneficiary of your retirement account to a charitable remainder trust that will benefit both a child or other family members and our future. This may be especially helpful if your IRA will make payments to a group that includes one or more older beneficiaries. IRA rules state that funds must be completely distributed over the life expectancy of the oldest beneficiary. Tax and financial benefits will be better if payments can be stretched out and paid over the term of the charitable remainder trust for 10, 15 or 20 years, rather than for life. 11 Qualified Disclaimer. At the very least, consider making us the contingent beneficiary of retirement plan death benefits and give your heirs the right to disclaim benefits. Heirs who understand the severity of taxes may decide it best to have retirement assets pass to a worthwhile cause and channel the gift to our mission. A spouse may disclaim and have the IRA pass to a charitable remainder trust of which he or she is the lifetime income beneficiary. 12 Sharing with Family Members. Heirs may not need the shrunken amount that would be left from retirement assets after taxes. However, friends can make bequests of retirement accounts and purchase life insurance to replace what a family member would have kept, after taxes. Some donors prefer to leave a percentage of 8
their IRAs for our benefit and divide the rest among other beneficiaries. 13 Or you can arrange for retirement death benefits to pass to a charitable remainder trust that would pay income for life or, alternatively, for a term of up to 20 years to family beneficiaries, with eventual benefit to our future. 14 Please call our office if you are interested in making us a beneficiary of your retirement account. We will need to provide you with our correct legal name for the beneficiary form. M-IRA-CULOUS GIFT OPPORTUNITY If you could increase your charitable gifts by one-third or one-half, and not have it cost you a nickel, would you do it? Most people would respond, Of course! But how could such a thing be possible? Through 2011, that miracle is possible for people who have IRAs and are past the age of 70½. Background: Since 2006 Congress has passed extension legislation that allows donors over age 70½ to instruct IRA trustees to make transfers to organizations they support without incurring taxable income on those amounts. Up to $100,000 could be given in this manner. No income tax deductions are available for IRA gifts, but IRA donors can still save significant taxes. In fact, IRA owners potentially can increase their contributions to worthwhile causes by 17% to 53% and have the bonus paid for entirely by the tax collector. Who Can Make IRA Gifts? Donors must be past age 70½ on the date of the gift and have a traditional or Roth IRA. 15 Not everyone has contributed to an IRA, of course, but many retirement Supercharge Your Support by Giving through Your IRA If Your Anticipated Gift by Check Would Have Been: plans, such as 401(k) plans, 403(b) plans and others can be Your $100 $500 $1,000 $5,000 $10,000 rolled over into IRAs when Tax You Can Increase to This Amount Free employees retire or leave their Bracket by Giving through Your IRA 15% 25% $117 133 $588 666 $1,176 1,333 $5,882 6,666 $11,764 13,333 companies for other reasons. Are My Charitable Deductions 28% 139 694 1,390 6,944 13,888 Affected? While no deductions 33% 149 746 1,490 7,462 14,925 are available for IRA charitable 35% 153 769 1,538 7,692 15,384 distributions, IRA gifts will 9
not reduce the amount of charitable deductions a person can take for other contributions. Furthermore, you ll be removing a highly taxed asset from your portfolio. Check with your advisers as to state income tax consequences. How Does the IRA Law Let Me Increase My Gifts at No Cost? By channeling contributions through your IRA, you could increase your gifts to us by the amount of tax that otherwise would have come due whenever payments are made to you or your heirs. In effect, we would now be receiving the tax collector s share. To calculate different gift amounts than those shown in the table (to the left,) simply divide your anticipated gift by 1.0 minus your tax bracket. For example a person in the 28% bracket who usually gives $1,200 could contribute $1,200.72, or $1,667, at no additional after-tax cost. GIFT IDEAS WITH YOUR IRA n Increase Your Annual Giving. IRA funds are heavily taxed whenever you draw them out, at rates as high as 35%. Under the IRA gift law, however, you can redirect the tax collector s take on any distributions from your IRA. Example: Suppose you normally send us a check for $1,000 every year. The table on the previous page shows that, instead of writing a check, you could instruct your IRA trustee to send us $1,333. If you had withdrawn $1,333 from your account, the tax would have been $333 (assuming you are in a 25% tax bracket). That $333 now can be used in our programs and you will have increased your support by one-third, all paid for by the IRS. n Major Gifts. Phyllis has planned to leave us most of her IRA at her death, but confides she would prefer to see her gift at work now, during her lifetime. Under the old law, removing money from her IRA for charitable purposes might not have been fully deductible and posed other adverse tax consequences. Now Phyllis plans to direct a $100,000 gift from her IRA for the current year. n Tax-Saving Gifts. Many of our friends who are past age 70½ make gifts but receive no tax benefit because they don t itemize deductions on their tax returns. Robert, for example, gives $2,000 annually, but claims the standard deduction. If Robert wishes, he can transfer the $2,000 to us, rather than make his gift from other savings. His gift saves him the $560 he would have paid on the $2,000 when he is eventually required to take a distribution from his IRA (28% tax bracket). His gifts may reduce certain tax penalties, as well. 10
n No charitable deductions are allowed, but IRA gift amounts will not be included in donors incomes. Transfers to charities can reduce the value of the IRA, resulting in lower required annual distribution in future years. To make an IRA contribution, simply contact your IRA trustee or custodian and notify us of your plans. We will need to coordinate the gift with your IRA administrator. Please call our office to verify that the IRA gift law is renewed. IRA GIFT RULE BOOK n Donors must be past the age of 70½ and own a traditional or Roth IRA other retirement plans such as pensions, 401(k) plans and others are not eligible. Owners of SEP or SIMPLE IRAs who are retired are eligible. 16 n Only the IRA trustee can transfer gift amounts to a qualified organization. If IRA owners withdraw funds and then contribute them to charity separately, amounts withdrawn will be included in the donor s gross income. n IRA gifts may not exceed $100,000 and may be made only to qualified organizations. The ceilings on contribution deductions (50% of adjusted gross income for cash, 30% of AGI for long-term capital gain property) do not apply to IRA gifts. n Transfers can satisfy pledges, but they are not permitted to donor-advised funds or supporting organizations. 17 n IRA gifts cannot be made to charitable remainder trusts, for charitable gift annuities or any arrangements that provide a return benefit for the contributor. A FINAL WORD What will be your legacy to the next generation? Our development staff would be pleased to discuss how your goals and ideals can be blended, through good planning, into a planned gift or bequest that make a significant difference in our endeavors, memorialize your own life, and provide lasting satisfaction. We look forward to hearing from you! 11
NOTES FOR TAX ADVISERS 1. I.R.C. 219(g). 2. I.R.C. 72(t)(1). Exceptions to the 10% penalty include distributions on account of death or disability, distributions in substantially equal periodic payments over an owner s life expectancy, qualified medical or education expenses and purchases of a first home. Income tax is still due on the distributions. 3. See Table A-2, Reg. 1.401(a)(9)-9. 4. See generally, I.R.C. 408(a). Withdrawals can be made by account owners over 59½ without penalty and used for charitable contributions that will qualify for income tax charitable deductions. 5. The $100,000 limitation applies to the taxable year that the funds are paid from the regular IRA, rather than the year they are contributed to the Roth IRA. I.R.C. 408A(c)(3)(B). Neither the conversion amount, nor any amount included in income as a result of the minimum required distribution rules, is counted in applying the $100,000 limit. I.R.C. 408A(c)(3)(C)(i). 6. See I.R.C. 402(c)(9) and I.R.C. 408(d)(3)(C). Heirs who are not surviving spouses can establish rollover IRAs from inherited qualified plan accounts, under the Pension Protection Act of 2006. 7. An estate is allowed an income tax and estate tax charitable deduction for income in respect of a decedent (IRD) paid or permanently set aside, for qualified organizations. I.R.C. 642(c)(1), 2055(e)(2). 8. Computation notes: Income taxes on Harold s IRA include $5,000 of state income taxes, which are a deduction against his federal taxes. Estate taxes are based on laws in effect after 2010. In Sarah s estate, the federal estate taxes and state death taxes on her total $7 million estate are $732,500: $50,000 in state inheritance taxes and $682,500 federal estate tax. Omitting the $1,000,000 IRA from the taxable estate leaves $339,500 of estate tax and an assumed state inheritance tax of $30,000 on the remaining $6,000,000. State and federal death taxes attributed to the IRA are therefore $20,000 state and $343,000 federal ($363,000 total). The $343,000 of federal estate tax (but none of the state death tax) provides an IRD income tax deduction. State income tax is based on the full $1,000,000 (assuming a 5% rate), equaling $50,000. Federal income tax would be $1,000,000 minus $343,000 of IRD deduction for federal estate taxes, minus $50,000 state income tax, equaling $522,500, times 35% equals $212,450 federal tax. Add state income tax of $50,000 and the total income tax is $262,450. Shrinkage of Sarah s IRA, accordingly, is $1 million minus $363,000 in state/federal estate tax, minus $262,450 of combined income tax, for a total of $625,450 lost to taxes, leaving only $374,550 for heirs (37 on the dollar). 9. Financial and estate planners generally recommend clients leave retirement benefits through beneficiary designations that enable heirs ( designated beneficiaries ) to receive distributions over their life expectancies, thus preserving taxfree growth of the account for many years. 10. The IRS has approved a testamentary transfer of funds from a retirement account into a charitable remainder unitrust that was established during life (Ltr. Rul. 9253038), and a similar transfer to a unitrust established in a donor s will (Ltr. Rul. 9237020). The IRS also approved a plan by which a donor left the balance remaining in her IRA to a charity to fund a charitable gift annuity for a family member. The value of the IRA would be included in the donor s gross estate, but there will be an estate tax charitable deduction equal to the value of the IRA, less the value of the annuity. Neither the donor s estate nor the charity would owe income tax (IRD) on the IRA (Ltr. Rul. 200230018). 12
11. Note that a charitable remainder trust is generally not feasible if the trust is to last for the lifetimes of very young beneficiaries, due to the 10% minimum charitable remainder requirement [I.R.C. 664(d)(1)(D) and 664(d)(2)(D), 664(d)(4)]. A term-of-years charitable remainder trust would work for beneficiaries of young ages if the donor is agreeable to having distributions continue for a maximum of 20 years. 12. A spouse may disclaim in favor of a charitable remainder trust, but children or other heirs cannot make a valid disclaimer of IRA benefits into a charitable remainder trust if that person will be a beneficiary of the trust [Reg. 25.2518-2(e)(3)]. 13. A charity that is a co-beneficiary of a retirement account should cash out of the arrangement before September 30 of the year following the year of the donor s death. Otherwise, IRA payments to other beneficiaries would be accelerated. Timely cash out by charity permits a family IRA beneficiary to use his or her own life expectancy to calculate future distributions. 14. A disadvantage for the charitable remainder trust, which must be mentioned if the estate is subject to federal estate tax, is that the IRC 691(c) income tax deduction for estate taxes attributable to a decedent s retirement account is essentially unavailable if part or all of the account passes to the trust (Ltr. Rul. 199901023). 15. IRA owners must be older than 70½ on the date of distribution from the IRA to a qualified organization. I.R.C. 408(d)(8)(B). 16. Notice 2007-7; 2007-5 IRB, states that only ongoing SEP IRAs or SIMPLE IRAs or SIM- PLE IRAs are excluded. 17. A qualified charitable distribution is any distribution from an IRA directly by the IRA trustee to an organization described in I.R.C. 170(b)(1)(A), other than an organization described in I.R.C. 509(a)(3) or a donoradvised fund, as described in I.R.C. 4966(d)(2). The materials contained in this booklet are intended to show only some of the ways you can benefit our future and minimize your federal tax liability with examples of anticipated federal tax liability. Thus, you should not take any action without first consulting your attorney. Rebecca Rothey, CFRE Gift Planning Office 320 Cathedral Street Baltimore, MD 21201 (410) 625-8488 direct line rrothey@cc-md.org cc-md.org/planalegacy Copyright Published by R&R Newkirk. All Rights Reserved. 13