Advanced Marketing Forum Question

Charitable Giving with Qualified Plans

Question:
Gentleman has $5,000,000 in a qualified plan that he absolutely cannot use and wants to gift it to a CRT:

Can he transfer the qualified plan to a charity before he dies? If he can, does he have to recognize the income on his tax return before he takes the charitable deduction?

Or is his only alternative to first recognize the income on the $5M distribution and then gift it in a lump sum?

Reply #1:
Though there have been many attempts to get such legislation passed, currently there is no provision in the law that will permit a lifetime gift of a qualified plan or IRA directly to charity, or to a charitable trust. So, in order to gift plan assets to a CRT, the participant must first take a distribution from the plan, pay the tax on the distribution, and then gift the net amount to charity. Because the gift to charity is net of the income tax paid, the deduction will not fully offset the tax paid on the gross distribution. If the client wants to do a lifetime gift to charity from his plan, this is the only option.

If, however, the client would be happy requesting his plan to charity, he can name the charity the beneficiary of his plan. At his death, his estate will receive an estate tax deduction for the full amount of the plan, and the distributions to the charity from the plan will be income tax free due to the charity's tax-exempt status. As long as the estate did not need to invade the plan to pay estate taxes, then there would be no income tax liability either for the estate or heirs.

Further, if the participant feels the desire, he can use his required minimum distributions to make gifts to an irrevocable life insurance trust, naming his heirs the beneficiaries of the trust. The death benefit from the policy the trust purchases on the participant's life would then provide some measure of wealth replacement to the heirs of the participant.

Andy H. Fesler, JD
Advanced Designs Analyst
Pacific Life Insurance Company
Phone: (800) 800-7681 x7601
E-mail: afesler@pacificlife.com

Reply #2:
At the present time, the qualified plan would have to "distribute" first and then contribute to the Charity OR contribute to the Charity at death.

A lifetime distribution of the plan assets would cause current income tax. This would be offset somewhat by the charitable income tax deduction taken for the present value of the future interest being left to the charity. The amount of the income tax deduction would also be affected by the "type" of charity that would ultimately receive the gift. A public charity would allow for an income tax deduction of up to 50% of the Taxpayers AGI in one year but could be carried over for up to five more years. If the ultimate charity is a private foundation, there would be a $30 AGI limitation on the income tax deduction in a year. Of course, by distributing the qualified plan money, paying the taxes and transferring the remainder to the Charity now, the estate is reduced by $5 million AND the estate will not have to face IRD which would cause income and estate taxes to be due and which could have reduced the amount in the qualified plan at death by about 60%.

Let's assume the gift goes to a charitable remainder trust:

The income stream from the earnings in the CRT then comes out to the client by either a stated amount (CRAT) or by percentage of the value of the trust each year (CRUT). The client can then use some of that money to purchase a $5 million survivorship policy in an ILIT outside the estate which effectively replaces the asset lost to his family and makes it income and estate tax free when death proceeds are paid to the trust.

There is a bill pending in the Senate that would allow transfers from qualified plans directly to CRTs during life without income tax but it has not passed yet.

The alternative is to leave the QP at death to the CRT. This may require a waiver by a spouse now but the participant should be able to leave the benefits to the CRT at death. The estate will get a charitable estate tax deduction for the present value of the future interest and NO INCOME TAX will be owed upon transfer at death to the CRT. There will still be some estate tax owed. If we assume that the estate tax is paid from other estate assets, the CRT will have the full $5 million to reinvest. The income stream then comes out to the children or other named beneficiary who pay income tax at their current income tax rates. If the client chooses this alternative, he could replace the 5 million transferred with a survivorship policy in an ILIT outside the estate and in that way, give his children "two" inheritances - the whole $5 million which 60% would have been lost if in the estate- AND an income stream for life (assuming 40 years could be as much as $15-20 million, depending on the growth of the investment in the CRT or the stated payout.) The client could pay for this policy with other assets he has now that, if sold or gifted to the ILIT, then sold and used for premium, would also reduce the taxable estate further.

Jane Warner, Esq.
Director, Advanced Planning
Sun Life Financial
Phone: (800) 432-1102

* The foregoing is for broker/agent use only, and is intended solely for informational purposes. Nothing contained herein should be construed as legal or tax advice, and should not be relied upon for such. Legal and tax advice should only be obtained from your attorney or qualified tax professional.

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