Senior citizens that previously itemized deductions when filing income tax returns can now look to IRA assets to contribute donations through making Qualified Charitable Distributions (QCD) directly to charities. While this strategy is often utilized, seniors that have shifted their Required Minimum Distributions (RMD) to a charity can now exclude their income from a return and still accomplish their charitable goals.
Tax Law Changes Impacting IRAs
Congress has been busy this year making several changes to tax laws that affect IRAs, causing taxpayers to rethink the QCD strategy. First, Congress raised the age for when IRA owners are required to withdraw RMDs from 70 ½ to 72-year-old. However, Congress didn’t change the age at which seniors can donate IRA assets (which remains at 70 ½). As a result of the COVID-19 outbreak, lawmakers also placed a hold on RMDs for the tax year 2020. While IRAs are typically a major savings source for investors and can be a significant nest egg during retirement years, the 2020 RMD suspension aims to provide these accounts a chance to recover from recent market losses due to the pandemic.
Markets, and therefore investors’ IRAs, were significantly impacted at the onset of the coronavirus crisis. For example, the S&P 500 suffered a 35% drawdown between February 19th and March 23rd; and the Dow Jones Industrial Average suffered a 38% decline over approximately the same time frame. In response to this downward volatility, taxable IRA owners were given a pass concerning their 2020 RMDs.
With new laws, come new strategies. But before we discuss those, lets first revisit the old strategy and what rules still hold true. Owners of IRAs that are age 70 ½ and older can donate up to $100,000 of assets directly to qualified charities (not donor advised funds). These QCDs can count toward the required payout. Keep in mind, there is no tax deduction—however, these direct gifts are not included in gross income. This not only lowers your income tax but also lowers your adjusted gross income.
There are numerous levies in the tax code that are based on adjusted gross income, including the 3.8% surtax on net investment income, medical deductions, and how much your Medicare part B and D premiums will be in the coming year. This strategy has been very effective for taxpayers who no longer itemize due to the higher standard deduction that was introduced in 2018.
The Effect of Recent Tax Law Changes
Because of the recent tax law changes that allow a pass this year on RMDs, some taxpayers who normally take the RMDs and give it to charity may choose to make a double gift in 2021. This strategy would allow for a bigger tax break in 2021 through the contribution of two donations in one year when the RMD is required.
In addition, there is another twist to the changes in the tax law. This year, there will be a group of IRA owners that turn 70 ½, who are allowed to make donations from their IRAs but are not required to take RMDs due to the new age limit. These individuals may question whether they should they wait to donate until RMDs are required. Some taxpayers may choose to delay contributions, as depleting the IRA assets first might allow their heirs to receive the appreciated stock at death. This provides heirs a “step up” in basis on the stock (basis that is the fair market value at death) and skip the capital gains taxes on the growth.
Key Thoughts and Considerations
These strategies are not a “one size fits all” situation. RMDs are mandatory for traditional, taxable IRAs and are not a requirement for an investors’ Roth IRA. As always, we recommend having these important conversations with your CPA and Financial Advisor. These uncertain and volatile times are ideal for re-visiting tax and financial plans that you’ve already put in place or to take that initial step in planning for future financial strategies.