IRA Distributions During an Investor's Lifetime
You might think that you can withdraw money from an IRA and then offset what would be a taxable distribution with a charitable deduction. However, this is often neither feasible nor financially sound. Consider the following:
- Most IRA withdrawals made before age 59½ are subject to a 10% early withdrawal penalty, even if the funds withdrawn are donated to charity.
- The charitable deduction for cash contributions is generally limited to 50% of the taxpayer's adjusted gross income (AGI). IRA distributions to charities that exceed this limit may result in the loss or deferral of this deduction.
- If you're a high-income earner, some itemized deductions are phased out due to what's referred to as the "Pease" limitation, named for the legislator who sponsored the provision. This may reduce the value of your charitable contributions. This limitation comes into play if your adjusted gross income is $311,300 or more for married couples filing jointly or $259,400 or more for those filing as single.2 Your deductions will be reduced by the lesser of 3% of the amount by which your AGI exceeds these limits, or by 80% of the itemized deductions that are affected by this limit.
- In states that don't allow an income tax deduction for charitable contributions, IRA distributions will be subject to state income tax without any offsetting charitable deduction.
- Large IRA distributions must be recognized as taxable income, which could increase your AGI. Higher AGI may result in the loss of several valuable income tax deductions, including the medical deduction, the casualty-loss deduction, and miscellaneous itemized deductions. A higher AGI may also limit your ability to use the personal exemption. It could also mean an additional 3.8% surtax on net investment income — this applies if your AGI is more than $250,000 (for married couples filing jointly) or more than $200,000 (for those filing as single).
A Charitable IRA Rollover
The Protecting Americans from Tax Hikes (PATH) Act of 2015 allows individuals who have reached age 70½ to make tax-free distributions up to $100,000 from a traditional or Roth IRA directly to one or more qualified public charities (which does not include donor advised funds or most private foundations). Unlike previous legislation —originally enacted as part of the Pension Protection Act of 2006 and extended multiple times — the current legislation is "permanent," in that there is no expiration date. A charitable IRA rollover distribution is not included in the IRA owner's income, but it still counts toward the owner's required minimum distributions. Due to the phase out of itemized deductions and the alternative minimum tax, a charitable IRA rollover could be a much more tax-efficient way of making a lifetime gift.In addition, per Internal Revenue Service (IRS) Notice 2007-7, an IRA distribution to a qualifying charity in which the IRA owner has an outstanding pledge will be treated as a qualified charitable distribution, not a prohibited transaction.3
Naming a Charity as a Beneficiary of an IRA
Designating a charity as a beneficiary of your IRA can offer several benefits:
- The donation qualifies for the federal estate tax charitable deduction, so there's no estate tax incurred.
- Neither you nor your estate have to pay any income tax on the funds.
- The charity does not need to pay tax on the proceeds.
- You do not need to amend your will or trust agreement to change the beneficiary of your IRA.
Using a Charitable Remainder Trust to Receive the IRA at Death
While IRA charitable gifting strategies can offer significant tax advantages, strategies that utilize other types of assets may be more tax efficient. For instance, your tax liability may be lower when you donate property that has a low basis and large, built-in capital gain. Shares of stock or real estate often fit this description. Before implementing any charitable gifting strategies, review the impact on your overall wealth plan and consult with your wealth, legal and tax advisors.
1Investment Company Institute, Retirement Assets Total $24.1 Trillion in First Quarter 2016, June 23, 2016
2Internal Revenue Service, IR-2015-199, In 2016, Some Tax Benefits Increase Slightly Due to Inflation Adjustments, Others are Unchanged, October 21, 2015
3Internal Revenue Service, Miscellaneous Pension Protection Act Changes, Notice 2007-7
4 Internal Revenue Code, 26 U.S.C. 664 - Charitable Remainder Trusts
5Internal Revenue Code, Section 691, Recipients of income in respect of decedents