Greetings! I trust that you are well and enjoying life.
Last week I wrote to you about a value-added tax, the solution to the mess of an income tax system we experience in the U.S. I doubt Congress will pursue it, it makes too much sense. However, there are still strategies that can save you money if you are aware of them like the idea of making a charitable contribution from your IRA.
The Pension Protection Act of 2006 first allowed taxpayers age 70½ and older to make tax-free charitable donations directly from their IRAs. By making a qualified charitable distribution (QCD) from an IRA directly to a qualified charitable organization, older IRA owners were allowed to exclude up to $100,000 annually from gross income. These gifts, also known as “charitable IRA rollovers,” would otherwise be taxable IRA distributions.
You must be 70½ or older in order to be eligible to make QCDs. You simply instruct your IRA trustee to make a distribution directly from your IRA to a qualified charity. The distribution must be one that would otherwise be taxable to you. You can exclude up to $100,000 of QCDs from your gross income each year. And if you file a joint return, your spouse (if 70½ or older) can exclude an additional $100,000 of QCDs. Note: You don’t get to deduct QCDs as a charitable contribution on your federal income tax return–that would be double-dipping.
QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution from the plan. However, distributions that you actually receive from your IRA (including RMDs) and subsequently transfer to a charity cannot qualify as QCDs.
Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would be a bit more cumbersome and possibly more expensive. You would request a distribution from the IRA and then make the contribution to the charity yourself. You’d include the distribution in gross income and then take a corresponding income tax deduction for the charitable contribution. But due to IRS limits, the additional tax from the distribution may be more than the charitable deduction.
QCDs avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity–you don’t report the IRA distribution in your gross income, and you don’t take a deduction for the QCD. The exclusion from gross income for QCDs also provides a tax-effective way for taxpayers who don’t itemize deductions to make charitable contributions.
Can I name a charity as beneficiary of my IRA?
You can name a charity as beneficiary of your IRA, but be sure to understand the advantages and disadvantages.
Generally, a spouse, child, or another individual you designate as beneficiary of a traditional IRA must pay federal income tax on any distribution received from the IRA after your death. By contrast, if you name a charity as beneficiary, the charity will not have to pay any income tax on distributions from the IRA after your death (provided that the charity qualifies as a tax-exempt charitable organization under federal law), a significant tax advantage.
After your death, distributions of your assets to a charity generally qualify for an estate tax charitable deduction. In other words, if a charity is your sole IRA beneficiary, the full value of your IRA will be deducted from your taxable estate for purposes of determining the federal estate tax (if any) that may be due. This can also be a significant advantage if you expect the value of your taxable estate to be at or above the federal estate tax exclusion amount ($5,490,000 for 2017).
Of course, there are also nontax implications. If you name a charity as sole beneficiary of your IRA, your family members and other loved ones will obviously not receive any benefit from those IRA assets when you die. If you would like to leave some of your assets to your loved ones and some assets to charity, consider leaving your taxable retirement funds to charity and other assets to your loved ones. This may offer the most tax-efficient solution because the charity will not have to pay any tax on the retirement funds.
If retirement funds are a major portion of your assets, another option to consider is a charitable remainder trust (CRT). A CRT can be structured to receive the funds free of income tax at your death and then pay a (taxable) lifetime income to individuals of your choice. When those individuals die, the remaining trust assets pass to the charity. Finally, another option is to name the charity and one or more individuals as co-beneficiaries. (Note: There are fees and expenses associated with the creation of trusts.)
The legal and tax issues discussed here can be complex. Be sure to consult an estate planning attorney for further guidance. If we can help you with any retirement-related questions, don’t hesitate to call us.
Best regards,
Jeff Christian CFP, CRPC