Same Gift, Smarter Plan: How to Leave More to Family and Charities

In this episode of Financial Sentiments, Nick Haberling walks through a simple but powerful estate planning idea: when leaving money to both family and charity, which assets go to whom can matter just as much as how much they receive.

Using a real-world-style example, Nick explains why pre-tax retirement accounts like IRAs can be costly for heirs but highly efficient for charities, while appreciated assets such as a home or brokerage account may be better suited for family because of the step-up in basis. With the right structure, a charitable estate plan can potentially reduce taxes, simplify the transfer process, and increase the impact of every dollar left behind.

Read the original article here:
https://financialsentiments.com/blog/2023/11/16/maximizing-your-charitable-legacy-smart-strategies-for-tax-efficient-estate-planning

Have a question or want to talk about your financial plan?
Email Nick at nhaberling@hfgtrust.com or book a meeting here:
https://bookings.cloud.microsoft/book/HFGTrustNickHaberling@HFGTrust.com/?ismsaljsauthenabled=true

This episode is for informational and educational purposes only and should not be considered financial, tax, investment, or legal advice. Please consult your own professional advisors before making decisions about your estate plan. 

Transcript

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According to Giving USA, Americans gave an estimated forty-five point eight billion dollars to charity through bequests and estate gifts, including wills, trusts, and beneficiary designations in 2024. Americans are without question a very generous people, but generosity without strategy can cost your family and the charities you love real money. Today we're talking about a simple but powerful concept, which assets you lead to charity and which you leave to family. And this matters enormously from a tax standpoint. A small tweak to your estate plan could save your heirs tens of thousands of dollars. Hello and welcome to the Financial Sentiments Podcast. I'm Nick Haberling, a financial advisor at HFG Trust. And in this podcast, we explore the investment and planning decisions that actually simplify financial life, cutting through the noise to focus on what truly matters. Now, to make this concrete, let's walk through an example. Meet Barbara. Barbara is a widow. She's nearing the end of her life, and she wants to make sure her estate is in order before she goes. She's done well. Her net worth is $1.2 million spread across three different assets. First, she owns her home, worth $500,000. Second, she has a brokerage account. Think stocks, mutual funds, that kind of thing, also worth $500,000. And third, she has an IRA, her individual retirement account, worth $200,000. Barbara wants to leave money to two people, or rather, one person and one organization, her son and the St. Francis Animal Shelter, a charity she's always loved. So far, pretty straightforward. A house, a brokerage account, a retirement account, a son, and a charity. Now let's look at how Barbara plans to divide things up. Now, before we get to Barbara's plan, let me quickly explain something important about how assets work when you pass them on. Because not all assets are created equal from this standpoint. Barbara's home and brokerage account are what we'd call non-retirement assets. When Barbara dies, whoever inherits them will do so through her will. Her IRA is different. Retirement accounts, like IRAs, have something called a beneficiary designation. This is a separate form you fill out directly with the financial institution, completely outside of your will. Whoever is named on the beneficiary designation form gets their allocation of the funds. So Barbara has essentially two buckets. Bucket one, the will, which controls her house and her brokerage account, that's $1 million in total. And bucket two, the IRA beneficiary designation, which controls her retirement account. That's $200,000. So got it. Two buckets, two sets of rules. So keep that in mind. It's going to be the foundation of everything we're going to be talking about. So here's Barbara's current plan. What I'd call the default plan we most commonly see. For her IRA, she's named her son as the sole beneficiary. He gets all $200,000 of the IRA. For her will, she splits things 90-10. 90% to her son, 10% to the St. Francis Animal Shelter. Since the will covers $1 million in assets, that works out to $900,000 to her son and $100,000 to the shelter. Add it all up. Her son receives $900,000 from the will plus $200,000 from the IRA for a total of $1.1 million. The shelter receives $100,000 from the will. That sounds pretty reasonable on the surface. The numbers are what Barbara wanted. But here's the problem. From a tax standpoint, this plan is less efficient than it could be. And fixing it doesn't require changing the amounts at all, just where things come from. To understand why, we need to back up again to talk about two things: cost basis and how IRAs are taxed. Now stick with me, this is a very important part. Let's talk about cost basis first. Your cost basis in an asset is simply what you paid for it. If you bought a stock for $10,000 and it's now worth $50,000, your cost basis is $10,000, and you have $40,000 of what's called an unrealized capital gain. A gain that exists on paper, but is not taxed until you sell that asset. Now Barbara's home originally cost her $300,000 and it's worth $500,000 today. Her brokerage account had a cost basis of just $100,000, but it's now worth $500,000. Normally, if Barbara sold the entirety of her brokerage account, she'd owe capital gains tax on that $400,000. But here's where it gets interesting. When you pass away, your non-retirement assets, the house, the brokerage account, receive what's called a step up in cost basis. What that means is the cost basis resets to the market value on the date of death. So when Barbara's son inherits her brokerage account, his cost basis isn't $100,000, it's $500,000, the value on the day she died. When he eventually sells those investments, there's essentially no capital gain to tax. The same applies to the house. His cost basis goes from $300,000 in the house to $500,000 in the house. That step up in basis is one of the most valuable provisions in the entire tax code for heirs, and it only applies to assets that pass through a will, not IRAs. Now, when we get to the IRA, this is where the default plan starts to show its weakness. An IRA is a tax-deferred account, meaning the money inside it has never been taxed. The government has been waiting patiently for its share. When Barbara's son inherits that $200,000 IRA, the IRS finally comes calling. He'll have to take distributions from that account, and every dollar he pulls out is taxed as ordinary income, not at the lower capital gains rate, but at his regular income tax rate. And under what's called the 10-year rule, he has to empty the account completely within 10 years of Barbara's death. If Barbara's son is in the 22% tax bracket, that's $44,000 of taxes embedded in that $200,000 inheritance. If he's in a higher bracket, even more. Now here's the contrast that changes everything. Charities don't pay taxes. If a 501c3 nonprofit receives money from an IRA, they owe absolutely zero in taxes. Every single dollar goes directly to the charity. So think about what that means. Right now, Barbara has the St. Francis Animal Shelter receiving money from her will. Assets that already got to step up in basis and carry no embedded tax liability. But her son is getting the IRA, the one asset that comes with a big tax bill attached. We've got it backwards. But here's the beautiful part. The fix is simple and it doesn't cost Barbara or her son or the shelter a single dollar. The amounts stay exactly the same. We just move the source. Instead of naming the animal shelter as a beneficiary in her will, Barbara updates her IRA beneficiary designation to make the St. Francis Animal Shelter a 50% beneficiary. That routes $100,000 from the IRA directly to the charity. Then Barbara updates her will so that her son inherits 100% of the non-retirement assets. The full $1 million from the house and the brokerage account. Let's check the math. Barbara's son still receives $1 million from the will plus $100,000 from the IRA. A total of $1.1 million, identical to before. The shelter still receives $100,000. Also identical. But here's what's changed. The $100,000 that used to go to the shelter came from the brokerage account, an asset with no tax bite for the shelter anyway. Now that $100,000 comes from the IRA. And since the shelter is tax exempt, they will pay zero taxes. Nothing changed for them. For Barbara's son, though, a lot changes. Instead of inheriting $200,000 of taxable IRA money, he only inherits $100,000 from the IRA. His tax liability on the IRA just got cut in half. So let's go ahead and count the wins from this swap, because there are actually three of them. Win number one is the tax savings. If Barbara's son is in the 22% tax bracket, cutting his inherited IRA in half from $200,000 down to $100,000 saves him $22,000 in taxes. If he's in a higher tax bracket, the savings are even greater. Win number two, the step up in basis. Barbara's son now inherits the full $1 million in home and brokerage assets. Thanks to the step up and basis, when he sells those, he pays essentially zero capital gains tax. That's a huge advantage. And it's one he fully benefits from because he's receiving 100% of those will-based assets. And win number three is speed. The shelter gets its $100,000 faster. Assets distributed through a will have to go through the probate process. That can take months, sometimes even longer. IRA beneficiary designations bypass probate. So the shelter gets the funds directly, quickly, and can deploy them to help animals right away. Same money, better outcome for everyone. So let's go ahead and distill this down to a rule of thumb you can actually use. Rule number one IRAs, 401ks, and other pre-tax retirement accounts are the best assets to leave to charity. Why? Because charities are tax exempt. Every dollar from a retirement account goes directly to the cause, with nothing lost to taxes. These are the most quote unquote expensive assets to give to heirs, and the cheapest to give to charity. Rule number two, appreciated assets, stocks, real estate, investments held in a regular brokerage account, are the best assets to lead to heirs. Why? Because the step up in basis wipes out all the embedded capital gains. Your heirs inherit the full value with no tax on the growth that happened during your lifetime. Charitable giving is one of the most meaningful things you can do with the wealth you build, but a good heart deserves a good plan. A well-crafted estate plan doesn't just honor your values, it maximizes the impact of every dollar you leave behind. It means more money getting to your family and the causes you believe in. If today's episode has you thinking about how your estate, financial, and investment plans interact, I'd be happy to work with you to make sure the right assets are getting to the right people or organizations in the most tax-efficient way possible. If that sounds like you, you can reach out to me directly by email. The address is in the show notes, or if you'd prefer, you can schedule an introduction meeting at your convenience using the calendar link. Also in the show notes.

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This podcast is for informational and educational purposes only and should not be considered financial, investment, tax, or legal advice. Opinions expressed are the representative's own and may change over time. Investing involves risk, including the potential loss of principal. Before making any decisions, please consult with your own financial, tax, or legal advisor. This podcast is produced by a representative of HFG Trust, a Washington state chartered trust company.