For retirees who are charitably inclined or for whom gifts to charity are an integral part of their ongoing budget, age 70.5 remains a key milestone, even after the SECURE Act and the SECURE 2 Act shifted the Required Minimum Distribution (RMD) age. The SECURE Act, signed into law in 2019, moved RMD commencement from age 70.5 to 72. The SECURE 2 Act, signed into law in 2022, further adjusted it to 73 for those born in 1951 or later, and to 75 for those born in 1960 or later. What remains available at age 70.5 are Qualified Charitable Distributions (QCDs). QCDs allow a person to transfer up to $105,000 per year tax-free from their IRA to a qualified charity. Notably, QCDs are only allowed to be made from an IRA., but no other qualified accounts. With the decoupling of the RMD commencement age and the age at which QCDs become available comes the opportunity to engage in proactive tax planning and provide potential tax efficiency for the charitably inclined.
For Retirees already taking IRA withdrawals
For retirees relying on IRA distributions ahead of RMD commencement and for whom charitable giving is a part of their budget, moving to QCDs at age 70.5 can provide immediate tax benefits. With today’s historically high standard deductions ($29,200 for Married Filing Jointly, and $14,600 for Single filers, plus additional amount for being age 65 or older) many retirees who give to charity are not itemizing their deductions. Ahead of age 70.5, these retirees are taking taxable IRA distributions, giving a portion to charity, and receiving no immediate tax benefit. At age 70.5, these retirees can instead switch to using QCDs. This will allow them to send funds directly from their IRA to the qualified charity of their choice and exclude these IRA distributions from their income. Not only can this lower their total taxable income, but it can lower their Adjusted Gross Income (AGI). A lower AGI can have several benefits. This can include lowering the taxable portion of Social Security benefits, avoiding higher Medicare premiums, minimizing the Net Investment Income Tax, and maybe even allowing other credits and deductions which are all AGI sensitive.
For Retirees Not Taking IRA Withdrawals
Some retirees have amassed enough in after-tax assets to stave off taking IRA withdrawals until RMDs commence. For these retirees QCDs will not lower their AGI or their taxable income. However, there are several compelling reasons these retirees should leverage QCDs at age 70.5, even though they not required to withdraw from their IRA.
- Opportunity Costs. When considering charitable giving strategies for individuals over the age of 70.5, it's essential to view after-tax assets and IRA assets through the lens of comparative advantage. After-tax assets, such as brokerage accounts or savings, offer greater flexibility and tax efficiency for various forms of consumption, including personal spending, gifting, and wealth transfer. On the other hand, IRA assets face less favorable tax treatment when used for these purposes due to the income tax liability on withdrawals. However, that disadvantage goes away when IRA assets are used for charitable giving through Qualified Charitable Distributions (QCDs). By directing up to $105,000 annually from an IRA to qualified charities via QCDs, individuals can fulfill their philanthropic goals while avoiding recognizing any taxable income. To optimize the tax efficiency of one's asset allocation, it's advantageous to preserve after-tax assets for non-charitable expenditures and prioritize using IRA assets for charitable giving through QCDs. This strategy ensures that each type of asset is employed in the manner that yields the greatest tax benefit based on its comparative advantage.
- Cost Efficiency. If an individual wishes to gift $10,000 to charity, we can examine the relative costs of doing so with a QCD or with after-tax assets.
An individual is required to withdraw $10,000 from their IRA for an RMD, and also has cash in a savings account of $10,000. They need $10,000 to fund living expenses for the year, but also plan to give $10,000 to charity. They are in the 24% tax bracket, and do not itemize their deductions.
Scenario 1 – They could give $10,000 of their existing cash to the charity, and then use the $10,000 RMD the IRA to pay for living expenses. That RMD would be taxable and would cost them $2,400.
Scenario 2 – They could instead send the RMD directly from the IRA to the charity as a QCD, and then use their other cash to fund their living expenses. The IRA withdrawal would be non-taxable, thereby saving them the $2,400 tax cost.
- A “Government Match”
In the above scenario we see the cost of replacing after-tax assets with IRA assets. Another way to see this scenario is the government providing a kind of “match” on the charitable donation. If we consider all IRA assets to have an associated tax liability, the tax-free nature of the QCD allows a retiree to satisfy their charitable inclinations and use money they would have otherwise paid out in taxes to do so. This allows a retiree to be philanthropic and avoid eroding their portfolio with taxes.
- Posterity
When a retiree passes away, assets held in an IRA are considered Income in Respect of Decedent (IRD). IRD assets are taxable to the beneficiary just as they would have been if the retiree had continued living. The SECURE Act has made passing IRA assets to the next generation less efficient and less appealing with the repeal of the lifetime stretch. Previously, IRA assets inherited by children could be distributed over the life expectancy of the child. Now, most non-spousal beneficiaries of IRAs are subject to the 10-year rule, which stipulates that all assets held in an IRA must be fully distributed within 10-years of the owner’s death. In practice this generally results in these assets being taxed more harshly in the second generation than they were in the first. Instead of passing IRAs to heirs, it may be better to use those for charitable giving during lifetime (and even at death) while preserving the taxable assets to pass to the next generation.
Conclusion
Age 70.5 is still relevant for retirees who are charitably inclined. The utilization of IRA assets for charitable donations through Qualified Charitable Distributions offers a compelling tax advantage, amplifying the philanthropic impact of donations and providing a mechanism through which donors can effectively leverage what amounts to a “government match.” By choosing IRA assets over after-tax assets for charitable contributions, individuals can enhance the efficiency of their donations, benefiting both the donor and the charitable recipients. Financial advisors and donors should carefully consider this strategy in their philanthropic and tax planning to potentially optimize the benefits of their charitable giving.
JH2024-0410