What could be better than having more retirement money than you need? How about being able to give it to charity tax-free?
For the lucky investor who has amassed excess funds for old age, this option became permanent under a law signed by President Barack Obama in 2015. Previously, Congress approved this strategy year by year, often leaving investors scrambling.
After turning 70.5, owners of traditional IRAs are required to take annual required minimum distributions, or RMDs. The amount is a percentage of the investor’s IRA values as of the previous Dec. 31, based on life expectancy on government tables — 4 percent for a person expected to live another 25 years, 10 percent if just 10 years, for instance.
[See: 7 Stocks to Buy for the Baby Boomer Retirement Wave.]
Because RMDs are taxed as income, many successful investors hate this rule. But with a qualified charitable distribution, IRA funds given to charity can satisfy this rule and escape tax that would apply if the funds were taken as a normal withdrawal. Up to $100,000 a year can be transferred directly from the IRA to a charity, all of it escaping tax.
“Many of my clients take advantage of the IRA charitable giving rule,” says Paul A. Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois. “I would say a third of my clients use their IRA accounts for charitable giving purposes.”
Not only will the QCD reduce your taxable income compared to a regular withdrawal, it could help with other matters by minimizing the adjusted gross income (AGI) on your tax return, Ruedi says.
“There are a significant number of items on your tax return that are impacted by the amount of your AGI, such as how much of your Social Security gets taxed,” he says. “(Minimizing AGI) can impact allowable losses from rental real estate activity with active participation. It can impact a number of miscellaneous itemized deductions.”
If the adjusted gross income is too high, deductions can be reduced for things like medical expenses and tuition, for example.
Like most tax savings, the benefits of qualified charitable distributions are biggest for people in higher tax brackets, including those potentially subject to an additional tax on long-term capital gains.
“I have a large number of high income retirees that give to charities from their IRA accounts,” Ruedi says. “For married couples, if they could not use the IRA for direct giving to a charity, they can easily have an income above the threshold for the 3.8 percent Medicare tax on capital gains (for high earners), turning a 15 percent tax into a 18.8 percent or a 20 percent to 23.8 percent.”
[See: 11 Ways President Trump’s Tax Plan Could Affect Americans.]
Investors with modest incomes can benefit as well, according to Kevin M. O’Brien, president of Peak Financial Services in Northborough, Massachusetts. Those who take the standard deduction on their federal returns, rather than itemizing deductions, can use a qualified charitable distribution to avoid income tax that would otherwise apply to an IRA withdrawal.
A QCD is like getting a deduction without itemizing, while still getting a standard deduction that might be bigger than one could get by itemizing.
“Many seniors find that they no longer benefit from itemizing their deductions because they have no mortgage interest deductions after they pay off their home and they have little or no state and local income tax to deduct because they are no longer working,” says Julia Brufke Wenger of Phoenix Tax Consultants in Phoenixville, Pennsylvania.
The bank, brokerage or fund company that has your IRA can help with the nuts and bolts of making a qualified charitable distribution, but here are a few things to keep in mind:
Age requirement. The giver must be 70.5 at the time the gift is given, not just by the end of the year. This is so, also, if the gift is from an inherited IRA.
Money limit. The limit of $100,000 a year per giver applies to all an investor’s IRAs lumped together, not to each account individually. That makes sense as the RMD is calculated on the sum of all IRAs, though the withdrawal itself can be taken from any way the investor wants — all from one account, equally distributed or divided unevenly. Each spouse can give up to $100,000 a year, but only from his or her own accounts.
Direct payment. The payment to the charity must come from the IRA trustee. If the check comes from the investor, the IRS could disallow the qualified charitable distribution and assume the investor received a normal distribution subject to income tax.
“The charity needs to be alerted as we have found that they usually receive this gift from the IRA custodian without the donor actually identified,” says Patrick Renn, president of The Renn Wealth Management Group in Atlanta.
Only IRAs. Qualified charitable distributions can be made from traditional IRAs or rollover IRAs created by transferring funds from a workplace plan, like a 401(k). They cannot be from workplace plans, SEPs or Simple IRAs.
Qualified charity. The gift must go to a public charity, not a private foundation. Check with the charity before making the gift. The qualified charitable distribution rule does not apply to withdrawals from donor-advised funds
Don’t double dip. Your tax break is from not having the IRA withdrawal counted as taxable income, so don’t also list it as a charitable deduction.
Don’t short your RMD. Be sure you’ve covered your entire required minimum distribution, either with the gift or, if the gift isn’t large enough, by also taking a regular withdrawal to make up the difference. The penalty is 50 percent of the amount that should have been taken but wasn’t.
[See: 12 Tips for Investors in Their 50s and 60s.]
No do-overs allowed. If you’ve already taken a required minimum distribution withdrawal for the year, you cannot undo it and use a QCD instead. You’ll have to pay tax on the RMD. Just remember to plan ahead next year. That shouldn’t be hard as next year’s required minimum distribution will be based on your IRA values this Dec. 31.
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How to Give to Charity and Pay Less in Taxes originally appeared on usnews.com
