Technicality Lowers Charities’ Take From Retirement-Fund Bequests

Planned-giving experts say that a minor provision of federal law

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may discourage people from bequeathing their retirement-plan money to charities.

According to the provision — which is part of the law that governs the distribution of assets from many kinds of retirement accounts — charities are considered to have a life expectancy of zero. That designation, in effect, forces people who name a charity as a beneficiary of their retirement plans to take bigger-than-usual distributions from the account once they have reached 70½ — the age at which people who have set up plans are required to start withdrawing money annually.

The large distributions mean that people have less money in their accounts as they grow older, and that charities and other beneficiaries of the plans, such as the planholders’ children, will inherit less money.

The provision also speeds up the time in which the plan’s assets must be paid out after the planholder’s death — in some cases forcing total withdrawals within one year. That means that other beneficiaries, such as the donors’ children, would have to take their entire share — and its tax liabilities — in a short period of time.

Donors can minimize the negative impact of the distribution requirements, including by splitting the plans so that non-profit groups and the donors’ heirs can be named the beneficiaries of separate accounts. That way the money in only the charity-named account would be subject to the less-favorable distribution rules.

Another option is for a donor to name a family member as the primary beneficiary of a plan, name the charity as the secondary beneficiary, and ask the family member to give up the rights to the plan’s assets upon the donor’s death, thus allowing the money to pass to the charity without having been subject to the more stringent distribution rules. With that strategy, the donor must rely on the primary beneficiary to renounce his or her rights to the money.

But even though arrangements can be made to skirt some of the distribution requirements, fund raisers and financial advisers say that the rules still may be keeping some donors from making bequests of retirement-plan assets.

“The things you have to do to get around the problems are not that complicated, but donors may see it as just another hurdle, another thing to worry about,” says Robert F. Sharpe, Jr., president of a planned-giving consulting company in Memphis. “The distribution rules definitely seem like an impediment.”

Some observers go a step further, calling the rules unfair. They point out that while splitting the plans into separate accounts may protect the donors and their families, charity beneficiaries still are harmed because they are likely to be left with depleted assets.

Cynthia Carr, Princeton University’s associate general counsel and executive director of planned giving, says that the rules treat strangers more favorably than charities. Since the distribution rules are based on the life expectancy of the planholder and the beneficiary, naming a person — any person — allows for more flexibility in distributions over time than does naming a charity.

“You can care a lot more about the American Cancer Society than about a total stranger off the street,” Ms. Carr says, “but under the present system, that stranger would get a whole lot more money than the American Cancer Society would.”

Christopher R. Hoyt, a professor of law at the University of Missouri at Kansas City, is perhaps the nation’s most vocal critic of the distribution rules. He has helped draft a proposal that members of Congress could use to amend the law to allow people to name charities or charitable trusts as beneficiaries of their retirement plans without jeopardizing their normal distribution requirements.

“The aim is to make naming a charity a non-event instead of a penalty,” Mr. Hoyt says.

But Ms. Carr and other charity officials say that they will probably wait for a more opportune time to push Congress to adopt that proposal, since non-profit groups have been busy lobbying Congress to change federal tax laws that affect gifts of pension money to charity while donors are still alive.

“I’m hopeful that the distribution issue will be next on our legislative agenda,” Ms. Carr says.