(or why you shouldn’t guess when making estate planning decisions)
A lady—let’s call her Debbie—recently shared with me an estate and charitable planning decision she had made. She had an IRA and a life insurance policy—both typically pass outside of probate according to beneficiary designations. In this instance, she had elected to give, upon her death, the IRA to her daughter and the life insurance benefit to her favorite charity. The insurance policy and IRA were nearly equal in value.
This is exactly what Debbie should NOT do. Here’s why.
First, when IRA assets are left to another person (instead of a tax exempt, public charity like the library foundation), that person will pay income tax on those assets at their own income tax rates. In our scenario, Debbie’s daughter would get the IRA assets, but would pay state and federal income taxes on all distributions from the IRA. The charity would have received the entire IRA—and paid no tax.
Second, in our scenario, the life insurance proceeds were left to charity. Now life insurance often makes a perfectly good gift, but not in this case when Debbie is trying to make a gift to her daughter as well. The better decision would have been to leave the life insurance proceeds to the daughter. She would have received the entire proceeds free of income tax.
So, our scenario is easily fixed. The better plan—if Debbie wants to maximize the gifts and minimize the taxes—she should leave the IRA to charity and the life insurance proceeds to her daughter.