A New Opportunity: Donating to Charity from Your IRA

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Congress has reinstated the ability to donate to a charity directly from your IRA without any tax penalty. You may benefit from this provision if you fit the right criteria.

The IRS normally collects tax every time you withdraw funds from your IRA. For example, if you take $100,000, the amount increases your adjusted gross income (AGI). It can cause your deductions to phase out or trigger taxation of your Social Security benefits. In the past this was true even if you subsequently donated the entire amount to charity.

In addition, many retirees do not itemize. Thus they were taxed on their charitable giving without the benefit of a tax deduction if the gift was below their standard deduction. If the gift was a significant percentage of their AGI, much of the write-off had to be carried forward and realized in subsequent years.

Artificially inflating your AGI has other negative consequences. Medical expenses and miscellaneous deductions must exceed a percentage of your AGI. So increasing your AGI may mean you are no longer able to take these deductions.

But the tax law signed on December 17, 2010, is less restrictive. It allows taxpayers age 70 1/2 or older to donate up to $100,000 from their IRA directly to a charity. The amount of the charitable contribution is excluded from taxable income. Therefore it won’t artificially inflate AGI and trigger an excessive tax burden.

You are normally required to withdraw a certain amount called the “required minimum distribution” (RMD) from your IRA account each year. Charitable contributions from your IRA can now satisfy this RMD requirement.

Because the law was passed so late in the year, you have until January 31, 2011, to make the transfers and still have them count for 2010.

You don’t have to be a big donor to take advantage of this opportunity. Perhaps your 2011 RMD is only $10,000. But you don’t need the money and normally give $5,000 to qualified charities. You can transfer half to charity. Only the other half will increase your AGI. This simple change could be enough to keep your Social Security from being taxed.

If your IRA contains both before-tax and after-tax dollars, you can save even more by giving. Qualified charitable distributions made from this type of IRA are taken from the portion of untaxed dollars first. This represents a radical departure from the typical IRA model that requires you to withdraw the pre-tax and after-tax dollars proportionately. Under the new act, you’ll be able to give away the dollars that carry the highest tax liability. At the end of the day, you’ll have a higher percentage of after-tax dollars left in your IRA.

All of these savings are liable to be small, perhaps only realizing about 5% of the value you give to charity. I’ve written previously about the benefits of giving appreciated securities in your taxable account. That technique is superior to this one in many ways, but not all. Giving appreciated securities adds the benefit of avoiding capital gains taxes that approaches an additional 15% benefit if the security is highly appreciated. But in some cases giving from your IRA would be the preferred method.

If you don’t have a taxable account with appreciated securities, giving from your IRA is clearly the next best choice. And if you are older and not planning on selling any of the appreciated securities, your heirs will get a step up in cost basis and realize the capital gain without paying any tax. If you don’t need the money for living expenses and already choose to do charitable giving, you might be the right candidate.

Transfers must be made directly to the charity or checks written made out to the charity. Each custodian has its own safeguards to ensure your transfer will qualify. No special forms are required. The IRS does not need to be notified. Your tax preparer will need to note the transfer on your taxes when you file.

Qualified charitable distributions are just one tax-planning tool that may save you money. We advise our clients to meet with their tax professional throughout the year long before the filing deadline. Tax planning is complex and time consuming but can be well worth the effort.

Photo by Kawin Harasai on Unsplash

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)

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Beth Nedelisky is part of the Investment Committee at Marotta Wealth Management and specializes in trust and endowment management. Born in Africa, raised in Europe and married in the USA, Beth understands world markets first hand.