The IRA Charitable Rollover – Laserlike Tool for the Seasoned Philanthropist

‘Tis the season…for charitable giving. In our last post, we discussed the basics of the new tax law, its possible effects on charitable donations and the concept of “bunching” and a Donor Advised Fund as a workaround. Today we address the IRA charitable rollover – or, more technically, the qualified charitable distribution (QCD).

IRA Goes Boom!                 

Traditional IRA’s can be ticking tax time bombs. It felt great to be relieved from paying taxes on the contributions. But the taxman must be paid, at ordinary income rates, when distributions are taken. (Remember, we’re not talking about Roth IRA’s here, which are taxed on contributions but not subject to tax on distributions.)

Contributions made directly to regular IRA’s are generally modest in amount – capped at $6,000 per year. So, it’s difficult to amass a significant amount in an IRA that way. But for ease of management, many people have rolled over their work-related SIMPLE IRA’s, SEP IRA’s and 401(k)’s into traditional IRA’s. And these can contain balances, including investment returns, of hundreds of thousands – or even millions of dollars. Altogether, Americans are estimated to hold nearly $10 trillion in IRA’s.

But distributions (RMD’s) are required beginning at age 70 ½; and continue for the rest of your life. The percentage required to be distributed begins at around 3.6% in the first year and increases each year until – for centenarians who remain alive – the entire amount must eventually be distributed. And taxed.  The RMD on a $500,000 IRA at age 70 1/2 is $18,248. The RMD on a $2,000,000 IRA – not inconceivable 10 years into a bull market – is $107,000 at age 80.

Uncle Sam to the Rescue

But for the charitably inclined, who don’t need their distributions for living expenses, the Qualified Charitable Distribution (QCD) is an effective mechanism for eliminating the tax burden of an IRA. The QCD originated in 2006 and survived, in fits and starts, until it was made permanent in 2015.

A QCD allows an IRA owner who is age 70 ½ and older to make a tax-free transfer of up to $100,000 per year directly from an IRA to a qualified charity (must be a public charity and not a private foundation) without reporting the distribution as taxable income. Consequently, the donor will not be allowed – and does not need – a charitable contribution deduction on Schedule A of the 1040. No withholding on the distribution will be needed or required. Some custodians may allow you to write checks to your favorite charities to easily utilize this tool. These rules also apply to the owner of an inherited IRA who is age 70 ½, even though the beneficiary’s RMD’s might have begun years earlier.

Crucially, these distributions satisfy the RMD requirement up to the $100,000 amount. You may take some of the RMD for your personal use and the balance can be donated to charity. Or an amount in excess of the RMD may be contributed up to the $100,000 amount. A regular program of utilizing QCD’s will systematically decrease the value of an IRA, lowering the amount of RMD’s required in future years.

Direct IRA giving is not hemmed in by the new tax law’s increased standard deduction and doesn’t require as much forethought as the bunching/DAF strategy. But does require you to act before December 31 and to make sure you haven’t already removed distributions for your own purposes, if you want to take full advantage.

QCD’s never become income taxable on your return and therefore are excluded from Adjusted Gross Income (AGI) – but should be reported as a QCD on line 15 of your 1040.

Only IRA’s for QCD’s

A QCD is not available for work related accounts, such as a 401(k), 403(b) or SEP or SIMPLE IRA’s. If you have one of these accounts you must first transfer or roll it over into a traditional IRA account in order to take advantage of the QCD rules.

It is however possible, as with an IRA, to leave part or all of such an employer related account to charity upon your death, via a beneficiary designation. Using such tax deferred accounts for post-death charitable giving can be a great idea because these inherited accounts are subject to income taxes in the hands of a beneficiary – while other assets, such as a regular taxable brokerage account may not be subject to income tax due to the availability of stepped-up basis. But this type of planning should be done with great care and with the assistance of your advisors.

Typical Caveats

You may not receive anything of value from the charity in exchange for your donation. However, unlike with a distribution from a Donor Advised Fund, a QCD may satisfy a pledge. (Be sure of course to consult with your own personal tax advisor on any of these technical issues.) And as with any other contribution, make sure you receive an acknowledgement from the charity for your gift.

Extra Benefits

Additional benefits of shunting IRA funds directly to charity – and lowering your AGI – might be avoiding higher income-based Medicare premiums and/or having less of your Social Security income taxed. These contributions are not subject to the 60% AGI limitation for deduction on Schedule A. And for the very wealthy, these transfers will reduce the size of the estate on which estate taxes might eventually have to be paid.

In summary, we are in a new era of charitable giving. Under the prior tax regime, you may not have considered using a QCD because you were easily able to take an itemized deduction for your charitable giving. But if you are 70 ½ and subject to RMD’s now may be different and it may be worth running some projections to determine your best strategy.

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