Leaving an inheritance to a favorite charity is a good intention. Like other nice intentions, however, it does not always work out. Allocating money to a charity in wills or trusts is a common estate planning mistake. Designating a charity as an heir or beneficiary in a will or revocable trust ignores tax consequences. The value of inherited holdings must be considered after taxes.
These tax consequences apply to assets passed on to family members when cash is designated for a charity. For example, the assets of an IRA are immediately taxable to the heirs regardless of whether they are distributed immediately or over time. Other assets, such as a home or after-tax savings account, are not taxable to heirs.
A better plan is to leave part of the IRA to a charity. This lowers the tax liability for family members and other heirs who can make up the loss of the IRA by receiving the tax-exempt cash that would have gone to charity. Charities are also tax exempt from any contributions made from the testator’s IRA.
Tax concerns, however, do not apply to a Roth IRA or a Roth 401(k). Distributions of these assets to heirs are tax exempt. There is no reason to designate these assets to charities. An IRA beneficiary form must be filed with the brokerage firm or through an employer. It is also important to update beneficiaries after important life events like divorce, remarriage or births. A former spouse, if listed as a beneficiary, may unintentionally receive the assets of an IRA even if a person remarries.
An experienced estate attorney can draft a valid will or trust that meets a person’s intentions and gets more assets to intended family members and other heirs.