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New Employee Benefits Laws Create Opportunities for Charities
By Jeff Belfiglio
[September 2002]
GIFTS
TO CHARITY FROM AN IRA OR RETIREMENT PLAN: NEW RULES MAKE IT PAINLESS
New tax rules allow individuals to make charitable bequests of
their interests in IRAs or qualified retirement plans without adverse
tax consequences. The rules create a powerful tool for individuals
seeking to realize charitable goals and for charities seeking to
develop planned gifts from donors who have substantial retirement
assets.
Savvy estate planners have long recognized that naming a charity
as a beneficiary of an IRA or qualified retirement plan account
on the owner’s death is a very effective means of charitable
giving. The gift creates an estate tax deduction, and does not create
an income tax liability for the estate. There were also downsides
to this tax planning technique, however. An IRA with a charitable
beneficiary could be required to make larger minimum distributions
during the IRA owner’s life, whereas owners with other sources
of income generally prefer smaller distributions in order to defer
tax liability. Naming a charitable beneficiary also accelerated
distributions to other beneficiaries after the owner’s death,
whereas it is often more advantageous to spread distributions over
the expected life of the beneficiary in order to defer taxes. As
a result of these disadvantages, planners often avoided naming charities
as beneficiaries even if gifts to charity were part of the owner’s
overall estate plan.
New Treasury regulations remove those obstacles and make it easy
for individuals to make a tax-favored gift to charity from an IRA
or qualified retirement plan upon death. Naming a charity as a beneficiary
no longer affects the distributions the owner receives during his/her
lifetime. After the owner’s death, the new rules allow a period
of time before the “designated beneficiaries” are finally
determined. During that time, charitable beneficiaries can be paid
off in full and eliminated from the calculation of payout periods
for the remaining beneficiaries. This allows individual beneficiaries
to receive payments over their life expectancies. The new rules
require that such cash-outs occur by September 30 of the year after
the owner’s death. Accordingly the owner’s personal representative
will have at least 9 and up to 21 months to pay the bequest to the
charitable beneficiary in full, so that other beneficiaries will
not be adversely affected.
Under the new rules individuals may make charitable bequests in
either a dollar amount or percentage of assets from an IRA or qualified
retirement plan account. The bequest must be made directly
from the IRA or plan by naming the recipient charity on a beneficiary
designation form for the plan. The estate should not be named as
the beneficiary, even if there are other charitable bequests under
the will.
The new rules address only gifts made upon death. There is currently
no opportunity to make tax-favored charitable gifts out of an IRA
or retirement plan while the owner is living. Legislative proposals
may change this situation in the future.
TAX LAW CHANGES ENHANCE RETIREMENT PLAN BENEFITS
FOR TAX-EXEMPT ORGANIZATIONS
Tax-exempt organizations can now provide significant retirement
benefits to key employees, as a result of recent changes in the
tax law. The changes substantially alter both the maximum permitted
annual contributions to a retirement plan and the way in which the
maximum is calculated. As a result, employers that maintain both
a Section 403(b) plan and a Section 457 plan, or both a Section
401(k) plan and a Section 457 plan, may now provide enhanced retirement
benefits.
Under the new rules an individual may contribute the lesser of
$11,000 (increased from $10,500) or 100 percent of his/her gross
compensation to a Section 403(b) plan. An employer’s contribution
is not counted in the limitation. Similarly, allowable contributions
to a Section 457 plan are now the lesser of $11,000 for 2002 (increased
from $8,500) or 100 percent of the individual’s taxable compensation.
The same limit applies for Section 457 plans whether the contributions
are made by the employee or employer.
Under prior law a tax-exempt organization that offered both a Section
403(b) and a Section 457 plan was required to apply the lower Section
457 plan limit on total contributions to both plans. Similar rules
applied for employee contributions to Section 401(k) and Section
457 plans. This effectively eliminated any benefit from offering
more than one plan.
Recent legislation has removed this constraint. Now, for purposes
of determining contribution limitations, each plan has a separate
limit. A tax-exempt organization that offers both types of plans
may accordingly contribute or allow eligible employees to contribute
the maximum amount to a Section 403(b) plan (or a Section 401(k)
plan) and the maximum amount to a Section 457 plan.
Section 457 plans now offer several opportunities for tax-exempt
employers:
- Highly compensated employees who want to save more can contribute
$11,000 annually to a Section 403(b) plan and another $11,000
to a Section 457 plan. If the employee is age 50 or older, he/she
may be able to contribute an additional $1,000 to the Section
403(b) plan in 2002.
- A Section 457 plan can enhance saving opportunities for highly
compensated employees, whose contributions to Section 401(k) plans
may be limited to less than $11,000.
- An employer can attract an executive without affecting its Section
403(b) plan by creating a one-person Section 457 plan with an
employer contribution.
The changes were effective Jan. 1, 2002. There is still time
to put a Section 457 plan in place this year to enable employees
to receive the benefits in 2002.
Any questions about this Alert should be directed to:
Jeff Belfiglio, Bellevue, (425) 646-6128, jeffbelfiglio@dwt.com
Ralph Hawkins, Seattle, (206) 628-7673, ralphhawkins@dwt.com
Jim Ambrose, Portland, (503) 778-5420, jimambrose@dwt.com
LaVerne Woods, Seattle, (206) 628-7792, lavernewoods@dwt.com
This TEO Alert is a publication of the Tax-Exempt
Organizations Group of Davis Wright Tremaine LLP. Our purpose in
publishing this Alert is to inform our clients and friends of recent
developments in tax-exempt and nonprofit organizations law. It is
not intended, nor should it be used, as a substitute for specific
legal advice as legal counsel may only be given in response to inquiries
regarding particular situations.
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