According to Giving USA, Americans gave almost $300 billion to their favorite causes in 2011. Charitable bequests by individuals totaled more than $24 billion, which represented 8 percent of the total.
In my experience, the topic of charitable giving rarely comes up at federal retirement planning seminars. So why talk about it now? Because as federal employees have seen a shift in their retirement benefits from a single defined benefit (under the Civil Service Retirement System) to one (under the Federal Employees Retirement System) that includes a significant savings component in the form of the Thrift Savings Plan, the topic has become more timely.
Keep in mind that when CSRS or FERS retirees die, their federal retirement annuity benefits end as well, with the exception of the survivor’s annuity. There is very little cash value to a federal retirement benefit, other than the employee contributions that are generally paid to the retiree (or survivor annuitant) within a few years following the beginning of the benefit payments.
But what if your survivors are not financially dependent on you? The balance of a retiree’s TSP account might be left to loved ones who are not financially dependent (such as grown children) or to a favorite charity. But doing so raises some complicated issues. I’ll address them generally, but if you should choose to pursue this idea, I recommend you talk to a professional about your options.
The first thing to understand is that the money in your TSP account has never been subject to income tax (with the exception of your Roth contributions). If you don’t withdraw the money during your lifetime and pay income taxes, then you will be leaving this tax burden to those who inherit the balance of your account.
Certain planning strategies might lessen the burden and leave more of your savings available to your heirs, but the TSP is not in the business of providing advice in this area. To figure out what to do, start by asking yourself a few questions. For example, your TSP beneficiary designation shows who will inherit the funds in your account, but how will they inherit them? And remember, once you’re retired and over age 70 ½, you must take required minimum distributions from your TSP for to satisfy your tax obligation. How will that affect the benefit that you wish to leave behind?
Kristina Sturgis, a planner with Ameriprise Financial, has helped me understand some of the concepts behind charitable giving and legacy planning. Here are some things she advises:
- Gifts to charities provide an income tax deduction if you itemize deductions on your tax return. A large gift to a charity can provide significant tax write-off and can provide additional income that would come from paying less income taxes in a given year or over several years. Sometimes it makes sense to make gifts while you are still living so that you can benefit from the tax savings.
- Give directly to a charity from an Individual Retirement Account and neither you nor the charity will have to pay taxes on the gift -- even if you don’t itemize your deductions. You can transfer payments from your TSP account directly to an IRA and you won’t have to report a taxable distribution from the TSP. You may set up a distribution from your IRA directly to a charity and there is no tax on these distributions.
- With the money you saved on taxes by donating directly to a charity from an IRA or from the itemized tax savings of the gift you gave, you may free up some money that could be used to fund a life insurance policy that could provide a tax-free benefit to your heirs.
- Consider that a larger gift to a charity could create an investment that can provide a stream of income to the charity. A gift of $50,000, for example, could provide a stream of $2,000 per year for many years.
Here’s a hypothetical example of using a legacy planning strategy.
Joe and Joan are former federal employees who both have retired under FERS. Joe has a benefit of $30,000 per year and Joan’s is $25,000. They are retiring at age 66, have claimed their full Social Security benefit and between them both have an additional income of $40,000 per year. The income from their FERS and Social Security benefits covers their monthly living expenses. They also have a combined total of $600,000 in their two TSP accounts, along with rollover IRA accounts from a previous employer worth $200,000.
After meeting with their financial advisor, Joe and Joan purchased a $600,000 variable life insurance policy with a survivorship. This income-tax free death benefit can be used to offset the taxes on distributions that their heirs will inherit. In addition, they can choose to leave their qualified assets to a nonprofit charity -- and still leave an inheritance to their loved ones.
If Joe and Joan chose to waive each other’s spousal survivor annuity, they would have 10 percent more retirement income (which would be taxable) to use for funding their insurance policy, because their respective FERS retirement benefits would not be subject to the 10 percent reduction to provide a survivor’s annuity. When one of them dies, the living spouse will have his or her monthly income cut in half, but will have all of their savings available.
Keep in mind, though, that purchasing a life insurance policy in lieu of a spousal survivor benefit is rarely advisable because it is difficult to determine the value of the survivor annuity -- and an annuity ensures that a non-federal surving spouse will get to continue Federal Employees Health Benefits Program coverage.
First Things First
The most important first step in incorporating a charitable giving strategy into your retirement is to make an overall plan for your fiscal future. That will involve filing certain legal documents, depending on what you decide to do. Keep in mind that laws can change that might affect the plan you have created.
Creating a plan for charitable giving and transferring your assets can be a complex, but rewarding, process. This is probably not a do-it-yourself endeavor for most people; you should discuss your options with a financial or tax adviser and perhaps an estate planning attorney.
You can get more details on your options by listening to Kristina Sturgis’ recent appearance on the For Your Benefit program on Federal News Radio.