It can be a wise estate-planning move to bequeath your IRA to charity and other assets to loved ones. Here's why.

Savvy estate planning means more than just figuring out who gets what. It's also about keeping a careful eye on the tax man — and employing strategies to make sure the IRS doesn't turn out to be a major beneficiary.

The strategy I'll cover today is geared toward those who own a traditional IRA and have charitable inclinations. For reasons I'll discuss, leaving your IRA to your charity of choice — while leaving assets held outside of it to your loved ones — is a smart way to stiff Uncle Sam. Allow me to explain.

IRA Money Can Get Taxed Twice, Three Times — Maybe More
A traditional IRA (meaning a deductible or nondeductible IRA — not a Roth IRA) can be a glorious thing. But our tax laws make a traditional IRA owned by a relatively well-off person a terrible asset to leave to a loved one. Why? Because IRA balances are potentially subject to double, triple or even quadruple taxation. Take a look.

Taxation #1: Federal Estate Tax
Under current tax law, if you pass away with a taxable estate exceeds that $1.5 million, your IRA balance will be included in your estate for federal estate-tax purposes. Now, $1.5 million might sound like a lot, but far more people surpass this threshold than you might expect. Should your IRA be subject to estate tax, that could cut your balance by 45% or more. To see if you'll be subject to this ugly tax, run your numbers through our worksheet. Keep in mind, assets left to a spouse are generally not subject to estate tax, but once that spouse passes away (assuming he or she didn't remarry), the estate-tax issue will once again rear its ugly head.

Taxation #2: Federal Income Tax
The taxable portion of your IRA balance (which, if all your contributions were tax deductible, is the entire amount) counts as "income in respect of a decedent" for federal income-tax purposes after you die. Translation? Withdrawals taken from your IRA by your estate or your heirs will be taxed as ordinary income, at rates that could run as high as 35%.

Taxation #3: State Income Tax
To add insult to injury, your IRA balance may be hit with state income tax, too. Maybe state estate tax as well, which would be taxation #4.

Now, I assume you didn't diligently sock away dollars all those years just to have your IRA demolished by taxes. So consider this: If you were already planning on leaving part of your estate to charity, consider allocating some or all of your IRA to that endeavor. The charity — unlike, say, your kids — will receive 100% of what you leave to it. Then you can leave other assets that aren't taxed so brutally (more on that below) to your heirs — which means more after-tax cash for them.

Charitable Giving and IRAs
When you name one or more tax-exempt charitable organization as a beneficiary of your IRA, they will receive their share tax-free. This is, in fact, the only way to leave IRA balances directly to charity under our current tax system.

Your only other alternative is to withdraw money from your IRA while you're still alive, pay the resulting income taxes and then give the remaining cash to charity. Unfortunately, your contributions may not be fully deductible for income-tax purposes, because there are restrictions on charitable write-offs. (For more on this, click here.) As a result, you may have to spread your charitable deductions over several tax years. In fact, depending on your income level, you may never be able to completely write off very large donations. So this is a very tax-inefficient way to satisfy your charitable urges.

By contrast, leaving IRA money directly to charities by designating them as account beneficiaries is a very tax-efficient thing to do. IRA balances left to a charity in this fashion are removed from your estate for federal estate-tax purposes. Plus there's no federal income-tax hit for your estate or heirs to worry about, and there's no income-tax hit when the tax-exempt charities withdraw their rightful shares of money from your IRA. There are no state taxes, either. So you avoid multiple taxes in a very simple and easy way.

Leave Other Assets to Loved Ones
What about your heirs, you ask? The best assets to leave them are things that are eligible for the federal income-tax basis step-up to fair-market value as of the date of your death. These types of assets include common stocks and equity mutual-fund shares held in taxable accounts, business ownership interests, real estate and just about anything else that would qualify for capital-gain treatment if sold. (For more on this, click here.)

Thanks to the basis step-up rule, your heirs can sell these assets with little or no capital-gains tax hit (only appreciation that occurs after your death would be taxed). Although these assets would be included in your estate for federal estate-tax purposes, there would be no double taxation.

Charities as Contingent IRA Beneficiaries
Now, you may be reluctant to irrevocably leave IRA money to charity, for fear of shortchanging your loved ones. If so, consider naming your favorite charities as contingent IRA beneficiaries. That way, the primary beneficiary (often your spouse) can choose either to accept the IRA money or let it go to the contingent charitable beneficiaries by disclaiming any interest in the IRA. The same tax advantages explained earlier apply when IRA money goes to charity in this less-direct fashion.

This Strategy Works for Other Retirement Accounts, Too
Unfortunately, the tax rules are equally harsh when you try to leave other types of tax-deferred retirement accounts to loved ones. Therefore, the leave-it-to-charity strategy makes sense for these accounts, too. Eligible accounts include 401(k), profit-sharing, SEP and Keogh accounts. If you're married, state law might require you to get your spouse's permission before naming charities as beneficiaries of these types of accounts.

One account you don't want to leave to charity, however, is your Roth IRA. Instead, you should leave Roth IRA balances to your human heirs by designating them as the account beneficiaries. That's because a Roth IRA — unlike a deductible or nondeductible IRA — is a great estate-planning tool. (For more, click here.)

As long as at least one of your Roth IRAs has been open for more than five years before withdrawals are taken by your heirs, all their withdrawals from any and all of your Roth IRAs will be federal-income-tax-free to them. But if you leave Roth IRA money to charity, this valuable tax break goes to waste. Remember: The required five-year period before federal-income-tax-free withdrawals can be taken starts on Jan. 1 of the year for which you made your initial contribution to any Roth IRA.