Retirement plans: A tax favored way to make gifts

"Qualified" pension plans may offer the least expensive way to make charitable gifts, including charitable contributions to Mississippi State University. Retirement plans increase rapidly because the assets build up tax-free. At some point, however, tax must be paid on the funds in these plans.

If withdrawals are made during the donor's lifetime, income taxes must be paid on untaxed contributions to the plan. If withdrawals come prior to age 59 1/2, there generally is a 10 percent penalty on top of the regular tax rate. Beginning at age 70 1/2, a plan participant must begin withdrawing the funds and paying tax on them.

At death, any amounts remaining in the funds are included in the gross estate and may be taxed at rates of 55 percent or more. Also, when the heirs receive the funds which are left after estate tax, they must then pay income tax, which was never levied during the participant's lifetime.

For example, if $100,000 is in a retirement fund at death and is taxed at 55 percent, the $45,000 remaining could be taxed again at federal income tax rates as high as 39.6 percent, and possibly state income tax also. Consequently, the fund remaining for the heirs could be only $27,180 or less. That's only 27 cents on the dollar!

While the above scenario paints a bleak picture, there may be other options available to you. Suppose you intend to leave a $100,000 bequest from your estate to Mississippi State University. A better way to do this might be to leave other estate assets to your heirs and your retirement plan assets to Mississippi State. By doing this, you not only avoid ever having to pay income tax on the pension plan assets, you also avoid estate taxes by removing the assets from your estate and your heirs receive your estate assets minus only the estate tax.

This same principle applies to any size estate. Even if the estate tax doesn't apply, heirs still have to pay income tax on any funds received from untaxed assets in a pension plan.

Another possibility exists for outright gifts of retirement plan benefits during lifetime. Assume the same $100,000 plan assets as the example above, but the owner wants to give the assets now or over a period of a few years rather than through a bequest. In this case, the plan owner might decide to give $25,000 per year for four years. In doing so he or she withdraws $25,000 each year and makes a gift of these funds. The money would be included in his or her income each year and "wash out" as a charitable deduction. Consequently, the funds used to make the gift are in effect never subjected to income tax.

Interested in knowing more about tax favored ways to make gifts to Mississippi State University? Please contact the university's director of planned giving at 662-325-3410.