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If you're age 70½ or older, you may be able to convert otherwise taxable retirement income into a tax benefit. This article will describe the interaction between individual retirement accounts (IRAs), required minimum distributions (RMDs), and charitable donations that can lead to tax-favorable results even when taxpayers do not itemize their deductions.
As taxpayers age, tax laws require that they take RMDs from their retirement accounts. Prior to the passage of the SECURE Act, taxpayers were required to begin taking RMDs after they reached age 70½. After the passage of the SECURE Act, however, taxpayers can reach age 72 before they are required to take RMDs from their IRAs. Generally, the amount of a taxpayer’s RMD is included in taxable income. However, taxpayers that have reached age 70½ are allowed to make direct contributions from their IRA to qualified charitable organizations, up to $100,000 per tax year. Interestingly, the changes to the RMD age threshold did not affect the age at which the IRA charitable contribution is allowed. Thus, even if taxpayers have not reached an age where RMDs are required, they can still choose to make charitable contributions from their IRA if they have reached age 70½.
The amount contributed to the charity from the IRA, which qualifies as an amount in satisfaction of the taxpayer’s RMD if they are required to take a distribution, is not taxable to the taxpayer. Since the income isn’t taxable, a separate charitable deduction cannot be claimed for the contribution. To receive the benefit, the IRA funds must be contributed to a 501(c)(3) organization. Contributions can be used to support multiple charities, as long as the sum of the distributions is within the $100,000 limit. Taxpayers can even donate part of any RMD to charity and withdraw the rest of the distribution as retirement income.
It is important to note that funds must be transferred directly from the IRA to an eligible charity
It is important to note that funds must be transferred directly from the IRA to an eligible charity by the IRA trustee in order to qualify for the tax-preferred treatment. A taxpayer who withdraws from their IRA and then donates to a charitable organization will pay taxes on the income. Donors should communicate their intent with qualifying charitable organizations in advance so that the organization can provide necessary information to the IRA trustee.
The benefit can be twice as large for those married taxpayers filing jointly. Specifically, if a taxpayer files a joint tax return, the taxpayer and their spouse can each make a charitable contribution of up to $100,000. In any case, however, the RMD must be made by the end of the calendar year.
These tax benefits can be sizable for retirees, especially those who would not ordinarily itemize to take advantage of the general charitable deduction. For example, if a retiree in the 24% tax bracket makes a $5,000 IRA charitable contribution, the taxpayer’s income tax bill could be reduced by $1,200. Even a $1,000 donation could save the same taxpayer as much as $240 in taxes. The benefits of making a charitable contribution from your IRA are even larger for those in higher tax brackets. Thus, a direct IRA charitable contribution is a tax-efficient strategy if you won’t benefit from the charitable deduction but you would still like to meet your charitable goals in a tax-preferred manner.
Navigating the complexity of tax strategy for retirement income can be overwhelming. Contact your P&N tax advisor to discuss how to make the most of your situation.