New Employee Benefits Laws Create Opportunities for Charities

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.