Beginning at age 72, you are required to take annual distributions from your traditional IRAs. These withdrawals, referred to as required minimum distributions (RMDs), are calculated based on the preceding year-end account balance divided by a figure from the IRS Uniform Lifetime Table. Once your RMDs begin, the required distribution amount is projected to increase each year. IRA withdrawals are subject to ordinary income tax and failure to take required withdrawals can result in significant back taxes and penalties.
Here are two strategies for using traditional IRA distributions for tax-efficient charitable giving.
Qualified Charitable Distributions (QCDs)
Qualified Charitable Distributions are also known as charitable IRA rollovers. If you do not rely on your IRA withdrawals for living expenses, due to other sources of income, a QCD can be an effective, tax-efficient approach to charitable giving. Since IRA withdrawals are taxed as income, they not only generate a tax liability, but also have the potential to push you into a higher tax bracket, which in turn can have adverse tax effects on your Social Security payments and can increase monthly Medicare premiums.
A QCD, allows one to donate up to $100,000 per year to a qualified charity. A married couple filing jointly can each qualify for an annual QCD up to $100,000. The QCD goes directly to your preferred charity, which allows you to avoid paying taxes on the distribution since it is not reported as taxable income.
A QCD can, in some cases, provide greater tax savings than a cash donation because it reduces your Adjusted Gross Income (AGI). Potential benefits of lowering your AGI include reducing taxes on your Social Security benefits and allowing you to qualify for certain tax deductions and credits. Also, since a QCD is excluded from your taxable income, it allows you to receive a tax benefit from your charitable contribution even if you do not itemize deductions.
Establishing charitable beneficiaries for your traditional IRA can also be an attractive strategy. When your heirs inherit assets from a traditional IRA, they are required to pay taxes on future distributions at their own income tax rate. However, public charities, including donor-advised funds, pay no income tax on IRA income, which allows your full donation to support your charitable goals. Furthermore, it may be possible to use your IRA assets to fund gifts, such as charitable remainder trusts, that provide income to your heirs. A charitable remainder trust may allow a partial tax deduction while providing an income stream for your heirs. If you are interested in a charitable remainder trust, we recommend consulting an estate planning attorney.