Designating Beneficiaries for Retirement Accounts, Part III
A beneficiary designation form is a simple and accessible tool that allows donors to make testamentary charitable gifts and streamline the administration of their estates. A beneficiary designation is a way to transfer an asset to an individual, organization or multiple beneficiaries upon the owner's passing. For financial accounts such as individual retirement accounts (IRAs), a beneficiary designation is typically a paper or electronic form provided by the account custodian that allows the account owner to designate who will receive the asset upon his or her passing.
Beneficiary designations are an excellent way for donors to make estate gifts directly to nonprofits and to fund planned giving vehicles such as charitable remainder trusts and charitable gift annuities for loved ones. However, donors may not be aware of this benefit. Many individuals assume their retirement accounts will simply become part of the plan created by their will or trust. In many cases, directing a retirement account to pass through a will or a revocable living trust introduces unnecessary complexity and may disadvantage the intended beneficiaries. Fortunately, donors have a simpler option available for passing on their retirement accounts that will help fulfill their charitable intentions. Professional advisors can play a crucial role by offering a holistic approach to estate planning, which should include a discussion of beneficiary designations.
This article series focuses specifically on the role of beneficiary designations in testamentary transfers of retirement accounts. The first article explored the logistics of beneficiary designation forms and compared this method to other testamentary transfer mechanisms. The second article examined how retirement account beneficiary designations can benefit both family and nonprofits. This third article in the series discusses best practices for nonprofits when accepting gifts of retirement accounts transferred via beneficiary designation.
Good donor stewardship can help facilitate the testamentary transfer process. Nonprofit organizations can ensure donors have easy access to the information that will enable them to fill out beneficiary forms correctly. Beneficiary designation forms typically ask an account owner to include the correct legal name, address, phone number and taxpayer identification number (TIN) of any beneficiaries. This same identifying information is also commonly included in the bequest language in a donor's will or trust. This information will help the custodian contact and verify the beneficiaries of a donor's retirement account. Since many nonprofit organizations provide donors with sample bequest language as a courtesy, it may be very useful to highlight that this same information is typically needed when filling out beneficiary designation forms.
As part of its stewardship efforts, a nonprofit should encourage donors to share their intention to give through a beneficiary designation form. In some instances, there may be significant delays from the time of the donor's passing to the notification of the charitable beneficiary. Educating donors and establishing a strong rapport with them and their families can help increase the likelihood an organization receives timely notification that it has been named as a beneficiary. A nonprofit's leadership should not assume custodians will be able to successfully locate and contact their organization in the event it is a designated beneficiary. In some cases, it will be necessary for a nonprofit to make the first contact with a custodian in order to claim the funds.
A nonprofit may stay informed of a donor's intentions by distributing non-binding pledge forms, gift notification surveys and information about its legacy society to its donors. While the donor retains the ability to modify his or her wishes, it is useful for the organization to know that a future gift may be coming its way. The nonprofit is also given an opportunity to acknowledge the donor's generous intentions during their lifetime.
Crescendo's beneficiary designation widget, available on GiftLegacy Pro websites, provides an excellent opportunity for donors to share their intention to give from their retirement accounts. The widget is integrated directly into a nonprofit's planned giving website. This feature conveniently links donors to their custodian's website where they may be able to update their beneficiary designation form electronically. The widget also invites the donor to notify the nonprofit of the beneficiary designation gift. If the donor chooses to provide notification, the organization receives an email with the donor's name, email and any additional comments, creating an opportunity for the organization to connect with the donor and show its appreciation.
Some donors may prefer not to share their charitable intentions in advance. Donors who wish to maintain their privacy and flexibility can still be educated on the value of keeping their loved ones informed. Important decision makers should be aware of where they can locate important account information.
At the end of each year, Stacey reviews her estate planning portfolio. In addition to her will and power of attorney documents, this portfolio includes statements from each of her financial accounts as well as a copy of the beneficiary designation forms for each account. This portfolio is kept in a fireproof safe in her home. Stacey also maintains an electronic copy of these documents on a USB flash drive in her safe deposit box, along with a copy of the code to access her home safe. Stacey has made arrangements with her bank to ensure that her daughter and son, who are named primary and secondary executor of her estate, will have access to the safety deposit box after her passing. She informs her children of the arrangements she has made and notes they will find a letter containing her final wishes in her portfolio. This letter includes a list of the individual and charitable beneficiaries Stacey would like her children to notify in the event of her passing.
While some donors wish to keep their personal affairs private during their lifetime, they can still set up a succession plan to ease the transition at the end of their lifetime. This advance planning can help ensure the executor of the donor's estate will be able to distribute the assets according to his or her wishes in an expeditious manner.
Once a nonprofit receives notice it has been named the beneficiary of an account, a best practice is for the organization to promptly request a direct transfer from the custodian. Generally, since the nonprofit intends to take a lump sum of the IRA funds, the simplest distribution method is through a check or electronic transfer of funds.
In accordance with Stacey's wishes shared in a letter to her children, her daughter informs the Smalltown Animal Shelter of Stacey's passing and that Stacey named the organization as a beneficiary of her IRA. Stacey's daughter gives the organization the custodian's contact information and her mother's account number. The organization's president drafts a letter to the custodian and includes the following information:
A statement that the Smalltown Animal Shelter has been named as a beneficiary of Stacey's IRA
Stacey's name and account number
A request for a lump sum to be distributed to the nonprofit within 30 days
Smalltown Animal Shelter's address for receipt of the funds
Smalltown Animal Shelter's tax ID number (TIN) and IRS tax exemption letter
The above example includes some of the most basic information that a nonprofit may be asked to provide in the process of claiming an IRA gift. A nonprofit may also wish to proactively include additional information to further clarify the basis for its request.
Some challenges may arise in the process of a nonprofit claiming an IRA beneficiary designation gift. Because many IRA beneficiaries are individuals, some custodians may be unaware of the different procedural considerations that arise when a nonprofit organization is named as beneficiary.
Individual beneficiaries often wish to withdraw inherited IRA funds over a number of years so they can realize the income tax consequences of the inheritance over a period of time. A beneficiary who withdraws inherited traditional IRA funds will pay the associated income taxes in that year, which may result in the application of a higher tax rate. For many beneficiaries, withdrawing inherited IRA funds over a period of time will reduce the potential for the undesirable, upfront tax burden associated with a large lump sum withdrawal and allow the remaining IRA funds to continue to grow tax free. As such, individual beneficiaries of significant IRAs will often elect to take a five-year, ten-year or life-expectancy-based distribution schedule when available, rather than a lump sum payment.
In contrast, a nonprofit does not obtain a tax benefit from delaying its receipt of IRA funds because it is entitled to the funds free of any income tax liability. Nonprofits would prefer to receive the IRA funds in a lump sum so they can be used to fulfill the donor's intent.
However, nonprofits often report that to collect an IRA gift, custodians attempt to require them to proceed as if the organization were an individual person. The nonprofit may be asked to open a new account, provide the personal information of its employees or submit to tax withholding. When named as the beneficiary of an IRA, a nonprofit should anticipate receiving one or more of the following inquiries and prepare accordingly.
Request to Open an Inherited IRA
A nonprofit does not have an interest in opening a new IRA to receive a donor's gift. However, a custodian may suggest that the nonprofit must set up a new account as part of its routine procedure with respect to individual beneficiaries. Nevertheless, under Reg. 1.408-2(b), an IRA must be set up for an individual rather than an organization. Therefore, it is not appropriate for the organization to set up a new IRA for its own benefit.
Custodian Request: Your organization must open a new account to receive these funds.
Potential Response: Our charitable organization is not qualified to set up an inherited IRA. Per Reg. 1.408-2(b), an IRA must be for the "exclusive benefit of an individual or his beneficiaries" and our organization is not an individual. As such, it is appropriate to transfer the funds directly to our organization.
Some organizations report that custodians are willing to make a lump sum distribution, but others have found that certain institutions insist upon the nonprofit organization first creating a new account prior to withdrawing the funds. The process of setting up a new account, even if only held open for a short period of time, can lead to the nonprofit's staff being put in the challenging position of unnecessarily sharing their personal information to open the account.
Request for Personal Information
Nonprofit staff are sometimes instructed by custodians to report personal identifying and financial information about its employees and board members. This request may be cited as stemming from the Patriot Act or FINRA Rule 2090 ("Know Your Customer"). These rules are intended to prevent the funding of terrorism. A nonprofit that wishes to take a direct distribution should be excluded from these types of rules pertaining to opening an account since the nonprofit does not wish to open an account.
Custodian Request: The Patriot Act requires us to obtain the Social Security numbers of your board members as well as their financial records.
Potential Response: Our organization does not intend to open a new account. The Patriot Act Sec. 326 provides that if an individual or corporation attempts to open a bank account, financial institutions must take steps to reduce the risk of funds being used by suspected terrorists or terrorist organizations. Our organization is not required to provide this information because we do not intend to open a new IRA.
In the event a custodian insists upon a nonprofit opening an IRA, the organization can provide its IRS exemption letter, demonstrate its current good standing and affirm it is not on the known or suspected terrorist lists. The nonprofit may want to affirm its position and continue to refuse to open a new account. IRA funds are held by the custodian as a fiduciary on the designated beneficiary's behalf. As such, the custodian has a fiduciary duty to distribute the funds according to the beneficiary's request.
Tax Withholding and Reporting
The tax-exempt status of a nonprofit can create some challenges for custodians working with administrative systems designed for individual account holders. The custodian may cite the need to withhold taxes from a charitable organization's IRA distribution. Some custodians will relay that due to software limitations, it cannot produce the appropriate IRS Form 1099 for a distribution to a charitable organization.
Custodian Request: We must withhold a percentage of the IRA distribution to be delivered to the IRS for tax purposes. We cannot produce the appropriate Form 1099 for you on our systems.
Potential Response: While IRA distributions to individuals are generally subject to tax withholding, IRS Form W-4P allows us to elect no tax withholding. As a qualified tax-exempt charitable organization, we are not subject to income tax. We will accept a manually generated Form 1099 in the event one cannot be produced automatically.
These examples reflect a few of the challenges nonprofits report when attempting to claim IRA gifts from custodians. In some cases, the obstacles arise from procedures that are designed to accommodate individual account owners. In other cases, obstacles arise from a lack of understanding about the differing needs and requirements of a nonprofit as beneficiary.
Crescendo offers two specimen letters to assist nonprofits with the collection of IRA funds. A nonprofit may wish to customize one of these letters and send it to the IRA custodian in the process of collecting a beneficiary designation gift. The first letter is targeted at custodians that require nonprofit beneficiaries to create inherited IRAs. The second letter is intended for custodians that do not impose such a requirement. These specimen letters are available within GiftLaw Pro Section 4.6.3 under "How to Collect Charitable IRA Beneficiary Designations."
Best Practices for Nonprofits
Nonprofit staff should familiarize themselves with the situations described above and expect these requests to arise when claiming an IRA gift. It should be emphasized that the IRA custodian, as trustee of the donor's account, has a fiduciary obligation to comply with the donor's testamentary wishes. Reg. 1.408-2(b). The failure of an IRA custodian to deliver the funds in a timely fashion may potentially subject the institution to a claim of breach of fiduciary responsibility. In holding a custodian responsible for making a timely distribution of an IRA gift, a nonprofit is not only advocating for itself as the intended beneficiary, but also advocating in support of the donor's wishes.
If faced with a cumbersome transfer process, nonprofit staff should be prepared to speak with more than one representative from the custodial institution to facilitate an outright transfer. It may be necessary to ask the organization's counsel to provide the legal basis for its requirements. The nonprofit should prepare for an interactive process and expect to provide the organization's TIN, exemption letter and appropriate written evidence, such as a board resolution, that its representative is authorized to act on behalf of the organization. In some instances, escalating the matter to the state's attorney general or legislature may be appropriate to get a resolution.
There are significant efforts being made to advocate for the prompt release of beneficiary designation gifts to charitable beneficiaries. These efforts have already made great progress toward streamlining the transfer of charitable gifts with a number of major custodians. As donors continue to recognize the value of giving from retirement assets, the process of transferring IRA funds to nonprofit organizations will become more routine and the need to establish appropriate, simplified procedures will become increasingly apparent.
Gifts of retirement assets can produce excellent benefits for both donors and charitable organizations. Beneficiary designation forms provide donors with a simple and flexible way to give to nonprofits as part of their legacy plan. As tax-exempt entities, nonprofits receive the full value of the gift, without the income tax consequences applicable to individual beneficiaries.
To promote the efficient and timely transfer of beneficiary designation gifts, nonprofit staff should be aware of and anticipate the potential obstacles of receiving these gifts. In some circumstances, an organization named as an IRA beneficiary will need to engage in a dialogue with the custodian to expedite the transfer process. Importantly, donors and the nonprofits they support should not be discouraged from giving or receiving retirement funds.