What you need to know to take advantage of an important IRA provision
The charitable individual retirement account (IRA) rollover provides taxpayers with a mechanism for transferring their annual required minimum distributions (RMDs) directly to charitable organizations in order to exclude the distributions from their taxable income while simultaneously supporting the charities of their choice. This rollover is an attractive option for taxpayers who either don’t want or don’t need the extra taxable income from their RMDs.
Wherever you are in your tax planning process, just know that you’re not alone. The rules around RMDs, charitable IRA rollovers, qualified charitable distributions (QCDs) and planned gifts sound complicated to a lot of people, but rest assured that you’ve come to the right place to find out what they are and how they can benefit you. Read on to learn more, and then consult with your financial or legal advisor for advice on your specific tax situation.
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Understanding Required Minimum Distributions (RMDs) and Qualified Charitable Contributions (QCDs)
What are required minimum distributions (RMDs)?
The IRS requires owners of IRAs to begin annual withdrawals from these accounts when they reach a certain age. The amount that you have to withdraw is determined by your age, the amount you have saved in an IRA, and your life expectancy.
These distributions must be made each subsequent year, and failing to make a withdrawal may result in penalty taxes on the amount that should have been withdrawn.
In 2019, the SECURE Act made major changes to the RMD rules. If you reached the age of 70½ in 2019, the prior rule applies, and you must take your first RMD by April 1, 2020. If you reach age 70½ in 2020 or later, you must take your first RMD by April 1 of the year after you reach 72.
What are qualified charitable contributions (QCDs)?
Distributions from an IRA are usually treated as taxable income. However, you can avoid this taxable income by making a qualified charitable distribution (QCD). A QCD is a direct transfer of funds from your IRA trustee to a qualified charity.
Making a distribution is an easy process. Since you cannot make a distribution directly to a charity, your administrator must transfer the money directly to the charity. Simply contact your plan administrator and tell them you would like to make a charitable donation from your IRA. Typically, they will supply a distribution form for you to fill out and return.
At the end of the year, the administrator will provide you with a Form 1099-R so you can report it when you pay your income taxes. The distribution will go on your Form 1040 tax return, where you will report the distribution as a nontaxed QCD. See the Form 1040 instructions and contact your financial or legal advisor for additional information.
In order to be eligible to receive a QCD, a qualified charitable organization must meet requirements under section 501(c)(3) of the Internal Revenue Code. Qualifying organizations must be involved in religious, charitable, educational, or literary endeavors or the prevention of cruelty to animals and children, fostering amateur sports competitions (locally and internationally), testing for public safety, or scientific activities or operations.
Certain charities are not eligible to receive QCDs, including donor-advised funds, private foundations and supporting organizations. You are not allowed to receive any benefit in return for your charitable donation. For example, if your donation covers your cost of playing in a charitable golf tournament, your gift would not qualify as a QCD.
Charitable IRA Rollover as a QCD
What is a charitable IRA rollover?
A charitable IRA rollover is a qualified charitable distribution from a retirement account to a charitable organization. One rationale for making such a distribution lies in the benefits the donor can receive. These benefits can be significant in both tax savings and impact on a charity. This is especially true when a person is required to take a distribution from their retirement account.
For some, this distribution could increase their taxable income in such a way that it pushes them into a higher tax bracket. This could reduce eligibility for tax credits and deductions. To eliminate or mitigate the impact of this income, many charitably inclined people often make a type of qualified charitable distribution (QCD) referred to as a charitable IRA rollover. This is not treated as taxable income and allows people satisfy their required minimum distribution (RMD).
Benefits of an IRA charitable rollover gift
IRA rollover gifts have a handful of important benefits:
1. Gifts may satisfy or count toward the required minimum distribution (RMD) for the year.
2. Gifts are not treated as income.
3. Gifts allow donors to take advantage of federal and, in many cases, state income tax savings.
4. Gifts can be spread over several charities.
Example: For the 2022 tax year, a couple plan to file jointly. They are both age 75 and anticipate adjusted gross income (AGI) of $125,000, including $60,000 in RMDs. Although they will not itemize deductions, they still plan to make charitable contributions totaling $5,000. They will report federal taxable income of $98,400 ($125,000 AGI, less a standard deduction of $26,600—$24,000 plus an additional standard deduction of $1,300 each for being over 65), resulting in federal tax of $13,527.
If the couple instead makes the charitable contributions using QCDs, they will include the $5,000 in their RMDs but exclude it from gross income, resulting in a taxable income of $93,400 and federal tax of $12,427—a tax savings of $1,100. We have a free resource to calculate your RMD and your potential tax savings and help you get started on making a charitable IRA rollover—all in under 10 minutes.
Rules, Limitations and Forms
History of the IRA rollover option
The IRA rollover was born out of the Pension Protection Act of 2006 (PPA). It was important because it could help older taxpayers satisfy their required minimum distribution (RMD) requirements while achieving their charitable giving goals. It permitted individuals to roll over up to $100,000 from an IRA directly to a qualifying charity without it being included in their gross income. The PPA expired and was extended several times until it was made permanent in 2015.
Qualifying for an IRA charitable rollover
In order to qualify, a person must adhere to certain requirements:
- The donor must be at least aged 72 at the time of the gift (70½ if the donor reached that age before January 1, 2020).
- Distributions have to be made from the IRA trustee directly to the charity. If a distribution check is made payable to you, the distribution would NOT qualify as a QCD and would be treated as taxable income.
- Distributions must come from a traditional IRA or Roth IRA. Some plans—such as 401k, 403b and SEPs—are not eligible. (In 2022, the Roth IRA income limits increased slightly. Your Roth IRA contribution limit will depend on your tax filing status and your modified adjusted gross income.)
- Distributions from a split-interest vehicle such as a charitable lead or remainder trust are not permitted.
- Distributions to donor-advised funds, supporting organizations and private foundations do not qualify.
- A donor may not retain any benefit that would reduce their charitable deduction.
- The charitable distribution must be completed by December 31 in the year it is claimed.
- Total charitable distributions cannot exceed $100,000 per taxpayer per year. If a married couple files jointly, each may contribute up to $100,000. Any amount over this cannot be excluded from gross income.
- Donors may not retain any benefit in exchange for the donation.
- Donors can exclude their contribution from gross income but cannot claim a charitable deduction.
What is a donor-advised fund (DAF)?
A donor-advised fund, or DAF, is an account established as a means to support charities while achieving income tax savings. It allows donors to establish a fund to make charitable contributions over time while receiving an upfront tax deduction. Because any assets transferred into the account must eventually go to charity, the donor is qualified for a charitable deduction at the time of the contribution. Depending on the assets used to establish the fund, a donor can receive an income tax deduction of up to 60% of their adjusted gross income on that donation.
Do DAFs qualify as IRA charitable rollovers?
According to the Council of Foundations, “since such distributions do not count as qualified distributions from IRAs under these special rules, donors will have to first recognize those distributions as income. They then must calculate their charitable deduction according to the general rules pertaining to percentage limitations and itemized contribution reductions discussed below.”
How does a DAF work?
All a donor has to do is contact a sponsoring organization to establish an account. Since a DAF does not have a distribution requirement, the funds can be invested and grown until you want to support an organization and advise the fund manager that you would like to make a donation.
What assets can I donate to a DAF?
In addition to cash, there are a wide variety of assets that can be contributed to a DAF. Among the most common are appreciated assets such as:
- Stocks, bonds and mutual fund shares
- Privately held interests
- Real estate
- Retirement assets
- Life insurance policies
Contributions are generally tax deductible up to 60% of AGI for cash gifts and 30% for illiquid assets. The donor can take the tax deduction for the year that contribution is made. Any amount that exceeds the donor’s adjusted gross income can be carried forward for five years.
What are the rules for DAFs?
According to the IRS, a DAF is defined as a fund or account separately identified and operated by a section 501(c)(3) organization, which is termed a supporting organization. Once the account is established, the supporting ownership owns and has control over it. The donor, however, has nonbinding advisory privileges with respect to the distribution or investment of the funds. Because of the charitable purpose of the DAF, there are other rules that must be adhered to:
- Grants must be made to a public charity.
- Grants cannot be made to split-interest trusts.
- Grants cannot be made to a private nonoperating foundation.
- Grants cannot be made to an individual.
- The donor cannot retain a benefit or receive any goods or services in exchange.
How Do I Establish a DAF?
You should contact your financial or tax advisor to determine if a DAF is appropriate for you. They may also be able to advise you on reputable sponsoring organizations. Once you determine the organization with which you will establish a fund, typically you only need to complete a few forms and transfer assets. You will want to determine if the fees and grant policies of the sponsoring organization suit your goals.
IRAs as Planned Gifts
The IRA rollover is one way to make a tax-smart decision for charitable donations. Another strategy is to incorporate your traditional IRA in your estate plans. This is accomplished by leaving all or some of your IRA to a charitable organization while leaving other assets to your heirs.
IRA planned gifts vs. RMDs
Taking money from your IRA over the $100,000 IRA charitable rollover limit will require you to claim the income and will trigger additional taxes. You might qualify for income tax deductions, but your gross income could require this amount to be taken over a period of years.
A more tax-efficient strategy would be to name a charitable organization as a beneficiary. The result is more advantageous because:
- It removes the money from your estate for estate tax purposes.
- There is no federal income tax on the amount.
- There is no state income tax on the amount.
- The charity pays no tax on withdrawals from the IRA.
As you can see, when a charity is named as a beneficiary to your IRA upon your death, your estate and heirs avoid income tax and the charity receives your gift tax free. If you were to donate them during your life, multiple tax issues would arise.
Key Points for IRA Charitable Rollovers
In summary, charitable IRA rollovers provide a mechanism for taxpayers to make charitable gifts while reaping significant tax savings. However, there is a lot of information to become familiar with to ensure the process is managed correctly. Here are some of the key facts to know, along with links to the associated chapters above.
- IRA account owners are required to begin annual withdrawals after they turn 72 years old (70½ if the donor reached that age before January 1, 2020), per IRS rules (Chapter 1).
- A charitable IRA rollover is a donation, in the form of a qualified charitable distribution, from an IRA retirement account to a charitable organization. An account holder cannot make a distribution directly to a charity; instead the retirement plan administrator must transfer the contribution directly to the charity (Chapter 1).
- Generally, distributions from an IRA are treated as taxable income. However, a qualified charitable distribution in the form of a direct transfer of funds from an IRA trustee to a qualified charity provides a mechanism for a taxpayer to avoid this taxable income (Chapter 2).
- A qualified charitable organization must meet requirements under section 501(c)(3) of the Internal Revenue Code to be eligible to receive a QCD. Donor-advised funds, private foundations and some other charities are ineligible (Chapter 2).
- Charitable IRA rollover distributions must come from a traditional IRA or Roth IRA. Distributions from 401k, 403b SEPs and some other plans are not eligible (Chapter 3).
- Total charitable distributions in the form of charitable IRA rollovers cannot exceed $100,000 per taxpayer per year. If a married couple files jointly, each may contribute up to $100,000 (Chapter 4).
- IRA withdrawals used to make charitable distributions over the $100,000 IRA charitable rollover limit must be recognized as taxable income (Chapter 5).
DISCLAIMER: This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. No warranty or representation, express or implied, is made by Phoenix Children’s Hospital Foundation, nor does Phoenix Children’s Hospital Foundation accept any liability with respect to the information provided on our website. You should consult with your professional advisor(s) prior to acting on the information in this guide.