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When you turn 70½, you must begin taking required minimum distributions (RMD) from your pre-tax IRA’s and unless you are still working, your employer sponsored retirement plans as well.  The IRS forces you to take these distributions whether you need them or not.  Why is that?  They want to begin collecting income taxes on your tax deferred retirement assets.

 

Some retirees find themselves in the fortunate situation of not needing this additional income so the RMD’s just create additional tax liability.  If you are charitably inclined and would prefer to avoid the additional tax liability, you can make a charitable contribution directly from your IRA and avoid all or a portion of the tax liability generated by the required minimum distribution requirement.

It Does Not Work For 401(k)’s

 

You can only make “qualified charitable contributions” from an IRA.  This option is not available for 401(k), 403(b), and other qualified retirement plans. If you wish to execute this strategy, you would have to process a direct rollover of your FULL 401(k) balance to a rollover IRA and then process the distribution from your IRA to charity.

 

The reason why I emphases the word “full” for your 401(k) rollover is due to the IRS “aggregation rule”.  Assuming that you no longer work for the company that sponsors your 401(k) account, you are age 70½ or older, and you have both a 401(k) account and a separate IRA account, you will need to take an RMD from both the 401(k) account and the IRA separately.  The IRS allows you to aggregate your IRA’s together for purposes of taking RMD’s.  If you have 10 separate IRA’s, you can total up the required distribution amounts for each IRA, and then take that amount from a single IRA account.   The IRS does not allow you to aggregate 401(k) accounts for purposes of satisfying your RMD requirement.  Thus, if it’s your intention to completely avoid taxes on your RMD requirement, you will have to make sure all of your retirement accounts have been moved into an IRA.

Contributions Must Be Made Directly To Charity

 

Another important rule. At no point can the IRA distribution ever hit your checking account.  To complete the qualified charitable contribution, the money must go directly from your IRA to the charity or not-for-profit organization.   Typically this is completed by issuing a “third party check” from your IRA.  You provide your IRA provider with payment instructions for the check and the mailing address of the charitable organization. If at any point during this process you take receipt of the distribution from your IRA, the full amount will be taxable to you and the qualified charitable contribution will be void.

Tax Lesson

 

For many retirees, their income is lower in the retirement years and they have less itemized deductions since the kids are out of the house and the mortgage is paid off.  Given this set of circumstances, it may make sense to change from itemizing to taking the standard deduction when preparing your taxes.  Charitable contributions are an itemized deduction. Thus, if you take the standard deduction for your taxes, you no longer receive the tax benefit of your contributions to charity. By making IRA distributions directly to a charity, you are able to take the standard deduction but still capture the tax benefit of making a charitable contribution because you avoid tax on an IRA distribution that otherwise would have been taxable income to you.

Example: Church Offering

 

Instead of putting cash or personal checks in the offering each Sunday, you may consider directing all or a portion of your required minimum distribution from your IRA directly to the church or religious organization.  Usually having a conversation with your church or religious organization about your new “offering structure” helps to ease the awkward feeling of passing the offering basket without making a contribution each week.

Example: Annual Contributions To Charity

 

In this example, let’s assume that each year I typically issue a personal check of $2,000 to my favorite charity, Big Brother Big Sisters,  a not-for-profit organization.   I’m turning 70½ this year and my accountant tells me that it would be more beneficial to take the standard deduction instead of itemizing.  My RMD for the year is $5,000.  I can contact my IRA provider, have them issuing a check directly to the charity for $2,000 and issue me a check for the remaining $3,000.  I will only have to pay taxes on the $3,000 that I received as opposed to the full $5,000.  I win, the charity wins, and the IRS kind of loses.  I’m ok with that situation.

Don’t Accept Anything From The Charity In Return

 

This is a very important rule.  Sometimes when you make a charitable contribution, as a sign of gratitude, the charity will send you a coffee mug, gift basket, etc.  When this happens, you will typically get a letter from the charity confirming your contribution but the amount listed in the letter will be slightly lower than the actual dollar amount contributed.  The charity will often reduce the contribution by the amount of the gift that was given.  If this happens, the total amount of the charitable contribution fails the “qualified charitable contribution” requirement and you will be taxed on the full amount.  Plus, you already gave the money to charity so you have spend the funds that you could use to pay the taxes.  Not good

Limits

 

While this will not be an issue for many of us, there is a $100,000 per person limit for these qualified charitable contributions from IRA’s.

Summary

 

While there are a number of rules to follow when making these qualified charitable contributions from IRA’s, it can be a great strategy that allows retirees to continue contributing to their favorite charities, religious organizations, and/or not-for-profit organizations, while reducing their overall tax liability.

 

Michael Ruger

About Michael………

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

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Investment advisory services offered through Greenbush Financial Group, LLC. Greenbush Financial Group, LLC is a Registered Investment Advisor. Securities offered through American Portfolio Financial Services, Inc (APFS). Member FINRA/SIPC. Greenbush Financial Group, LLC is not affiliated with APFS. APFS is not affiliated with any other named business entity. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.