Situation: Your wealthy client, age 72, has a sizable individual retirement account and is wondering whether to make charitable contributions from the IRA in 2009.
Solution: Congress extended the provision to make charitable contributions directly from IRAs through 2009. This was considered a great benefit for anyone age 70½ and older. Then, in December, new legislation lifted the IRA distribution requirement for 2009. So, should clients use IRA assets in 2009 for charitable contributions?
There are several benefits to using IRA assets for charitable contributions. First, the client avoids paying tax on the distribution (at the ordinary income rates). Second, from an estate-planning perspective, an IRA is an inefficient asset because the income tax liability does not end at death. Therefore, to the extent it can be reduced in favor of assets that receive a step-up at death, the client’s heirs should benefit. On the other hand, assets in the IRA grow on a tax-deferred basis, thus leveraging the rate of return in the IRA. Furthermore, the client loses the income tax deduction if charitable contributions are made from an IRA.
To analyze the income and estate tax effects of this situation, we projected a hypothetical client’s balance sheet and cash flow for the next 16 years. Assume the client is age 72. In one scenario, the client used $100,000 of IRA funds for charitable contributions in 2009. In the other case, the client used $100,000 of investments for the contribution. We assumed the charitable contribution was deducted over four years, due to adjusted gross income limitations. To facilitate the analysis, we assumed a 7% rate of return inside the IRA or investment account.
After considering estate and income taxes, the difference is minimal. However, on a pre-tax basis, the client saves money if the distribution is made from non-IRA assets. Why? In either scenario, net worth has decreased by $100,000 before calculating the tax liability. However, the client who uses non-IRA assets saves about $40,000 in taxes due to the deduction. Plus, additional assets are allowed to build in the tax-protected environment of the IRA. With good
estate planning, the income taxes can be paid over many years following the client’s death, thereby adding to the benefit of keeping the IRA intact in 2009.
