A beneficiary designation form is a simple and accessible tool that allows donors to make testamentary charitable gifts and streamline the administration of their estates. A beneficiary designation is a way to transfer an asset to an individual, organization or multiple beneficiaries upon the owner's passing. For financial accounts such as individual retirement accounts (IRAs), a beneficiary designation is typically a paper or electronic form provided by the account custodian that allows the account owner to designate who will receive the asset upon his or her passing.
Beneficiary designations are an excellent way for donors to make estate gifts directly to nonprofits and to fund planned giving vehicles such as charitable remainder trusts and charitable gift annuities for loved ones. However, donors may not be aware of this benefit. Many individuals assume their retirement accounts will simply become part of the plan created by their will or trust. In many cases, directing a retirement account to pass through a will or a revocable living trust introduces unnecessary complexity and may disadvantage the intended beneficiaries. Fortunately, donors have a simpler option available for passing on their retirement accounts that will help fulfill their charitable intentions. Professional advisors can play a crucial role by offering a holistic approach to estate planning, which should include a discussion of beneficiary designations.
This article series focuses specifically on the role of beneficiary designations in testamentary transfers of retirement accounts. The first article explored the logistics of beneficiary designation forms and compared this method to other testamentary transfer mechanisms. This second article examines how retirement account beneficiary designations can benefit both family and nonprofits. The third article in this series will discuss best practices for nonprofits when accepting gifts of retirement accounts transferred via beneficiary designation.
Testamentary Outright Gifts
To make testamentary gifts of retirement assets, the account owner must list the beneficiaries' names and their respective percentage shares on the beneficiary designation form associated with the account. Additional information requested may include each beneficiary's address, phone number and tax identification or Social Security number. The beneficiaries may include individuals, trusts or nonprofits.
By making a charitable gift at death, the donor's estate receives an estate tax deduction. Retirement assets are a particularly attractive source of funds for testamentary charitable gifts due to the unique tax treatment of inherited IRAs. Individual beneficiaries must pay income tax on withdrawals from inherited traditional IRAs, whereas charitable beneficiaries do not. Due to a nonprofit's favorable tax treatment, the net benefit of a gift of retirement assets is greater when given to a nonprofit rather than to an individual. As a result, charitably inclined individuals will see great value in prioritizing retirement assets as a source of charitable gifts.
As discussed in Part I of this series, an IRA can be distributed through a donor's will or revocable trust document. However, by providing for the distribution of the IRA through the account's beneficiary designation form, the donor can simplify the designation process as well as the estate administration process. Whereas many donors would incur some expense in updating or redrafting a will or trust to change their beneficiaries, the beneficiary designation form can be changed by the donor at his or her discretion without a fee.
Teresa is an 85-year-old widow with approximately $100,000 held in IRA accounts. Some of these IRA funds were earned over the course of her career, and some had been transferred to her in the form of a rollover IRA upon her husband George's passing. In their retirement years, the couple had discussed their intentions of providing for each other and then dividing the remainder of their IRAs among ten of their favorite charities. Teresa and George had named each other as the primary beneficiaries of their IRAs, then listed ten charities as secondary beneficiaries, each receiving a 10% share. After George's death, Teresa updated the IRA beneficiary designation form to reflect the ten charities as equal primary beneficiaries.
Teresa notified her children and charitable beneficiaries of the charitable intentions she shared with George. She requested these testamentary gifts be recognized in their joint memory. Upon Teresa's passing, the children informed the charitable beneficiaries of the designations their parents had made. Teresa and George's children received kind notes from the various organizations. They were proud their parents had made a difference for many wonderful causes in their hometown.
Using a beneficiary designation form to make an outright gift of a retirement asset is a simple process for a donor. This designation can be easily modified during the donor's lifetime. A nonprofit that receives a testamentary gift of retirement assets will benefit from the funds to the fullest extent, since the nonprofit will not be subject to income tax on the distribution as an individual beneficiary would be.
A donor may appreciate the simplicity of using a beneficiary designation form, but also may desire to attain multiple goals through a gift for his or her beneficiaries. Fortunately, gifts made through a beneficiary designation are not limited to outright gifts. Beneficiary designations may name trusts or charities acting for the benefit of a beneficiary as recipients of IRA assets. A testamentary charitable gift annuity can be a convenient solution for a donor who wishes to leave a charitable legacy, but also hopes to provide support for family members or loved ones.
A charitable gift annuity (CGA) is a contract entered into by a donor and a nonprofit. A donor transfers property to the nonprofit and the nonprofit pays an income stream to one or two beneficiaries for their lives. Upon the termination of the lifetime payments, the remaining assets used to fund the gift annuity are available for use by the nonprofit.
CGAs are frequently set up during a donor's lifetime. However, in Private Letter Ruling (PLR) 200230018, the Service ruled favorably on an IRA owner's request to fund a testamentary CGA. In that ruling, the taxpayer proposed entering into a CGA agreement with a nonprofit. Pursuant to the agreement, the taxpayer would fund the CGA with a beneficiary designation gift from an IRA account. The Service ruled that the organization's tax-exempt status would not be adversely affected, and it would not have unrelated business income upon receipt of the IRA. The Service also ruled that the IRA would be included in the owner's estate, but the estate would not be taxed on the ordinary income of the IRA and would be eligible for a partial estate tax deduction. While a PLR does not serve as precedent, it is a useful indication of the Service's analysis of a particular issue.
A donor may establish either an immediate or deferred gift annuity. An immediate gift annuity begins making payments within twelve months of the gift date, whereas a deferred gift annuity begins making payments more than twelve months after the gift date. In the event of a delay related to estate administration or the transfer of the funds, the nonprofit that is party to an immediate gift annuity may find it must provide make-up payments from the time of the donor's passing to the time when the annuity contract is signed and funded. A deferred CGA helps mitigate the risk of this scenario. Since the deferral period allows for at least a year before payments begin, there is time for the nonprofit to be notified, draft the CGA contract and take possession of the funds after the donor's passing.
A deferred charitable gift annuity can also be used to ensure a beneficiary has attained a certain age prior to commencement of the payments. Although the nonprofit cannot predict the exact funding date of the testamentary CGA, the deferral can be structured to ensure the beneficiary is of sufficient age to meet the organization's gift annuity issuance guidelines.
The testamentary CGA allows for distributions to be made over a beneficiary's lifetime. The potential to distribute inherited retirement funds over a beneficiary's lifetime has been of particular interest since the passage of the SECURE Act in 2019. Prior to its passage, many inherited IRA beneficiaries took required minimum distributions tied to their life expectancy. For younger beneficiaries, this "stretch" distribution allowed for long-term tax-free growth within the account and the recognition of income tax over an extended period. The SECURE Act changed the rules such that most non-spouse beneficiaries who inherit IRAs must now withdraw the funds within a ten-year period. This shortened period accelerates the income tax consequences for individual beneficiaries.
The testamentary CGA can be thought of as an alternate way to accomplish the "stretch" distribution previously available to IRA beneficiaries. By allowing the IRA to be distributed over a longer period, the beneficiary's tax situation is less likely to be dramatically impacted in any given year. Furthermore, if the funds used to establish the CGA continue to grow over the payment period, they will ultimately provide a significant benefit to the nonprofit as well.
George and Eleanor are both 91 years old. They have three adult children who range in age from 68 to 72 years old. George and Eleanor live off the rental income generated by three small apartment buildings they have owned for many years. It has been understood in the family for many years that each child would ultimately inherit one of the apartment buildings.
George and Eleanor also have approximately $600,000 in their IRA accounts. While they strongly preferred to give their children real estate rather than a lump sum of cash, they feared their children might struggle keeping up with the expenses of the inherited properties if unforeseen expenses were to arise. Eleanor reminded George that they had received some literature from their local nonprofit animal rescue organization after attending a fundraising event for a remodel of their kennel facility. A description of a testamentary charitable gift annuity funded with an IRA had caught their interest.
The couple called the gift planner with the rescue organization to discuss the process of setting up a testamentary deferred CGA. They updated their beneficiary designation forms to reflect their intention to create a testamentary deferred CGA for each child. The IRA sums would be divided into equal shares to fund a two-year deferred charitable gift annuity for each child, with the payout rate for each child determined at the time of the parent's passing based on the ACGA suggested payout rate for the child's current age. This arrangement would allow each child to receive some income for life, with the remainder passing to the nonprofit. The couple completed a gift agreement to indicate their intention for their future testamentary CGAs to indicate that to the extent possible, the residuum of the CGAs would be used to support construction, remodel projects and continued maintenance related to the kennel facilities.
A charitable gift annuity can be a great tool for a donor who wishes to provide a lifetime benefit to one or more loved ones, followed by a future gift to charity. A testamentary CGA funded with an IRA can serve as an excellent substitute for the "stretch" IRA payout that was phased out by the SECURE Act. The extended distribution schedule provides a long-term income stream and allows the beneficiary to spread out the income tax over his or her lifetime.
Some donors wish to benefit their loved ones with an income stream but find that a charitable gift annuity does not provide the most suitable solution for their goals. For example, a donor may wish to use one gifting vehicle to support the educational needs of several grandchildren for a fixed term.
A testamentary charitable remainder unitrust (CRUT) can be structured to make payments for the beneficiaries' lifetimes, a term of years or a combination of the two. A charitable organization may be unwilling to issue CGAs for younger beneficiaries, due to their internal procedures and the extended life expectancy of the beneficiary. However, a testamentary charitable remainder unitrust can be an excellent alternative. A charitable remainder unitrust can be structured to make payments for a term of up to 20 years, making it appropriate for younger beneficiaries who would generally be ineligible for a CGA at many nonprofit organizations. In some cases, a CRUT could be created with lifetime payments for middle-aged beneficiaries. A term of years CRUT is well-suited for beneficiaries of any age who may benefit from extra support until, for example, they are more established in their careers, finish making student loan payments or reach their own retirement.
During the term of the trust, the trustee invests the assets and makes payments of at least 5% to the non-charitable beneficiaries. With a charitable remainder unitrust, the trust corpus is subject to annual valuation. The trust payment is recalculated based on the annual valuation. If the trust earns more than it distributes, the excess funds accumulate within the trust, increasing the trust corpus. Once the initial term is over, due to the death of the beneficiaries or the end of the term of the years, the remainder is distributed to one or more qualified nonprofits.
Jason and Kira are two successful physicians who met in medical school and married soon after graduation. For the last twenty years, they have dedicated their free time to a local nonprofit that provides medical care for children affected by domestic violence. When their son and daughter began preparing for college, Jason and Kira sat down with their estate planning attorney to revisit their plan. Although they had set up a revocable trust when the children were infants, they recalled that their IRAs were not part of their holistic estate plan due to the relatively small size of their IRA balances. Now, seventeen years later, they estimated they had accumulated approximately $1,000,000 in several IRAs.
Jason and Kira considered their options for their IRAs. On one hand, they did not want their children to receive a large inheritance all at once, in order to avoid the temptation of irresponsible spending. At the same time, they were concerned that if they planned a sizable outright charitable bequest at death, they might give away too much too early and disadvantage their children.
Their attorney suggested they consider a testamentary charitable remainder unitrust as a vehicle to distribute their IRAs. After the passing of the surviving spouse, the IRAs would be paid into the trust and then distribute 5% of the assets each year to their two children. After a term of twenty years, the remaining trust assets would flow to their favorite nonprofit.
Their attorney guided them on revising their beneficiary designation forms as well. Each of their IRAs named the other spouse as the sole primary beneficiary. They both identified the "Trustee of the J&K Family Charitable Remainder Unitrust dated July 4, 2021" as the secondary beneficiary. The forms would need to be updated upon the passing of the first spouse to ensure their plan is properly executed. The attorney explained that upon the passing of the surviving spouse, the trustee should contact the custodians for the various IRAs to coordinate the transfer process.
The attorney also noted that if the couple felt that circumstances no longer required the use of the trust, they were free to modify the beneficiary designations as desired and leave the IRA remainder to charity. Jason and Kira were reassured to know that they had an appropriate contingency plan in place while their children were relatively young, but that this plan could be reevaluated and adjusted as circumstances changed.
A testamentary CRT can benefit a number of individuals, including those who are younger than the typical age for issuing a gift annuity. The trust can be structured to provide distributions for a term of up to twenty years, so unlike a CGA, it does not need to be tied to a beneficiary's lifetime. Drafting the CRT document will require the assistance of the donor's counsel. Once the document is executed, the donor can facilitate the testamentary funding of the trust simply by revising his or her beneficiary designation form for the relevant account. During life, the donor will retain the ability to change which accounts will ultimately fund the trust at death and in what proportions.
Best Practices for Donors
When donors update beneficiary designation forms, it is a good practice to keep a record of the change in their files. This record keeping may involve, for example, retaining a copy of the beneficiary designation form along with periodic statements from the account showing its custodian, address, account number and current balance. This information is very useful for personal representatives and trustees to locate these assets and understand the arrangements for their distribution. It should not be assumed that the custodian of the account will discover an account owner's death or be able to locate the named beneficiaries. There is always a possibility that a beneficiary's contact information could become outdated and make it difficult for the custodian to determine how the property should be distributed. Furthermore, although the beneficiary designation form may allow the account to be transferred outside of probate court administration after the owner's death, the administrator of the estate may nevertheless need information about the account at death, such as its value for estate tax purposes.
Many donors have accumulated significant savings in retirement accounts. These types of assets are often attractive sources for charitable gifts made at death. Testamentary giving options for IRAs range from simple, outright distributions to more structured giving vehicles such as gift annuities and charitable remainder trusts. The common thread for these testamentary gifts of retirement assets is that they are made possible through beneficiary designation forms, which dictate how the IRA funds will be distributed after the owner's death. The beneficiary designation forms associated with IRAs make it easy for donors to name beneficiaries as well as change these designations as their wishes and life circumstances change over time.