By Elliot Dole, CFP®
It is remarkable how many charitably minded investors miss the opportunity to make gifts using IRA dollars before age 70½. Often this occurs because they have been told simply to wait until that age. Qualified Charitable Distributions (QCDs), of course, cannot be taken until age 70½ and come with an inherent deduction, since their otherwise taxable amount is never included in income. But why not effectively donate pre-tax IRA dollars beginning at age 59½ (or at any age for those with inherited IRAs) to manage your deferred tax liability (which grows with your pre-tax IRA balance) and make tax-efficient charitable donations earlier?
First, consider that money taken from an IRA after age 59½ is not subject to early withdrawal penalties. But it is taxable. Also, in 2020, taxpayers can deduct cash gifts up to 100% of their income. This results in a meaningful planning opportunity for retirement savers who itemize to use an IRA withdrawal to make charitable gifts tax-efficiently.
Next, understand that QCDs have some limitations other than age threshold. Gifts are limited to $100,000 per taxpayer per year, and must be paid directly from the IRA to end charities. This is problematic for wealthy families who want to use IRAs for charitable and legacy planning purposes – such as funding charitable trusts, private foundations, donor advised funds, and supporting organizations – during their lifetimes. QCDs also require coordination with the tax preparer so they are not included as income, because the taxpayer and IRS will receive a 1099 with the amount of the distribution and no indication some or all of it went to charity.
When looking at whether it makes sense to help meet your charitable giving and tax planning goals using IRA dollars, it is best to step back and view your legacy plan broadly over and beyond your lifetime. Start with your end legacy goals in mind. Retirement planning, bequests, charitable giving, preparing heirs, and income and estate tax planning are all interrelated components of an overall financial life plan that supports the goals you’re working toward.
Furthermore, recent changes – specifically the 2019 SECURE Act, which put in place a rule requiring non-spousal beneficiaries to distribute inherited IRAs within 10 years – limit the tax efficiency of passing IRA assets to children. And many families will be passing on substantial tax-deferred accounts to kids who inherit the IRAs in their peak earning years. But with some strategic planning, families may transfer more to their heirs and charity and less to the IRS.
Simply put, distributing dollars from your pre-tax IRA and donating cash or appreciated capital assets (like securities) to charity – as long as you are itemizing and the gifts are made with consideration to adjusted gross income (AGI) limits – means that there is no need to wait until age 70½ to sidestep income tax on the IRA distribution.
Currently, the deduction for cash gifts made to charity is limited to 60% of AGI, though in 2020 only taxpayers can make a special election to deduct up to 100% of income subject to some unique requirements. For instance, the donation must be cash and to the end charity, not to a donor advised fund or supporting organization. That means this year you could write off a cash gift equal to 100% of your AGI and funded through an IRA distribution. You could donate an entire IRA to charity. Even a very large one. Or part of one, and leave some balance remaining, maybe to position yourself for a Roth conversion or series of Roth conversions before having to take and meet RMDs down the road. Children may also plan to use inherited IRAs for their own charitable giving.
This approach may also be combined with a gift of appreciated securities held in a taxable account to bring additional tax savings and tax-free diversification opportunities. Keep in mind, though, that this year’s income tax deduction for a gift of appreciated securities held in a taxable account to a public charity is limited to 30% of AGI. Any excess may be carried forward up to five years. (As you can see, the nature of the asset you’re gifting – cash or appreciated securities – and the type of receiving organization can significantly affect what percentage of AGI the deduction is capped. You need to itemize, but that’s often possible with some planning.)
The takeaway is that distributing from tax-deferred IRAs after age 59½ (or even before that for inherited IRAs) and using those funds to give to charity is an approach that ought to be considered each year. Moreover, in 2020, the special election to deduct cash gifts up to 100% of AGI is particularly interesting for those over 59½ with large IRAs who would like to use their tax-deferred balances for donations to end charities. This election may be very compelling to a donor with a large outstanding charitable pledge best met with IRA assets. QCD age may be a long way off, and this approach would allow the charity to get and use the support sooner, perhaps also opening that door I mentioned for a series of strategic Roth conversions.
I’ll offer one additional caveat: Tax planning this year is being made especially difficult by a number of unanswered questions, many of which will be hashed out in the political arena. We know the rules and tax rates this year, and may suspect rates will rise in the future, but is that in 2021? Will we see phaseouts or other limits on itemized deductions? What about lower gift and estate tax exemptions? Who knows whether we’ll do better than the bird we have in hand today for the value of a straight itemized deduction for charitable gifts. So focus on where you want to go and the planning moves to make today will present themselves, even as the tax rules change.
About the author: Elliot Dole, CFP®
As a Wealth Advisor with Buckingham Strategic Wealth, Elliot Dole, CFP®, EA, AEP®, CExP™, CAP®, MS in taxation, helps families uncover their ideal vision for the future and then works with them to realize it through investment, tax, charitable, legacy, and comprehensive financial life planning.
Important Disclosure: The information contained in this article is for educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Individuals should seek advice from qualified tax professionals prior to implementing tax strategies. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded at any time without notice. Certain information contained herein is based upon third-party information and is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth®. IRN-20-1504