A New Tool for Giving

It took nearly 10 years, four renewals of temporary laws, two budget crises, and one government shutdown, but eventually our friends in Washington finally came together to give our communities a powerful tool for charitable giving both today and in estate plans. On Dec. 18, new legislation was signed into law which restored and made permanent the Charitable IRA Rollover.

A traditional IRA has long been, and continues to be, one of the best assets to give to charity through your estate plans. When you place money in a traditional IRA during your lifetime, you avoid paying taxes on those deposits. Then as those IRA assets are invested and grow over your lifetime, you avoid paying taxes on that appreciation. But a traditional IRA isn’t a tax-free vehicle, it’s merely tax-deferred. You can’t avoid the taxes forever. Eventually the taxman cometh and will force you to confront the reality that is the IRS.

Most people will never pay any estate taxes because the first $5.45 million of your estate can be passed on to your heirs free of any estate tax. That $5.45 million exemption is for 2016 and increases every year. However, because a traditional IRA is a tax-deferred vehicle, you can normally count on Uncle Sam to impose some form of tax on the IRA that you’ve left to your heirs, regardless of how large or small your estate. Traditional IRAs, like most qualified retirement plans, are taxed as what the lawyers call Income in Respect of a Decedent (IRD). In other words, when a taxable IRA is inherited, the new beneficiary who subsequently takes withdrawals from the IRA will pay taxes on it, just as the IRA owner would have had he or she still been alive.

That’s why when it comes to estate planning, a traditional IRA is generally the first thing you want to give to charity and the last thing to leave to your heirs. Instead, better assets to leave to your loved ones is anything that is highly appreciated and gives your heirs a step-up in costs basis (what you originally paid for the investment) such as stocks, bonds, and mutual funds held in your own name, or even real estate that has grown significantly in value. Even better, a Roth IRA (in which you paid the taxes up front and the subsequent growth occurs tax free) is a terrific asset to transfer to those you leave behind. Conversely, in your estate plans, taxable qualified retirement plans such as a traditional IRA are usually the first thing you want to give to your favorite charity because those organizations are generally exempt from taxation.

This has long been the case. What the new legislation changed was to restore and make permanent the so-called Charitable IRA Rollover so donors can now receive a tax benefit by making gifts to charity out of their traditional IRA during their lifetime. Now, anyone age 70½ or older can give up to $100,000 annually from their traditional IRA to charity completely tax and penalty free.

The typical person who will use this new tool is a senior who has “overfunded” their traditional IRA such that their required minimum distributions (RMD) provide more income than they need on an annual basis. You can now “rollover” up to $100,000 every year directly to the charities you love and exclude that amount from your gross income on your tax return. In other words, what would have otherwise been a taxable distribution paid directly to you is now a completely tax-free gift to charity.

As a further benefit, the IRS considers this a “qualified charitable distribution” which means that the amount you rolled over to charity counts toward your required minimum distribution for the year.

It’s easy to do. Just give the legal name, tax identification number, and mailing address for your favorite charity (or charities) to the custodian of your IRA. Many investment firms even allow you to download forms or submit the information online.

There are a few caveats to remember. Make sure the check is made out from your IRA directly payable to your selected charity. Do not make the check payable to you or you could find yourself having to declare it as income on your tax return. In addition, distributions to private foundations, supporting organizations, and donor advised funds do not qualify for the rollover. In those latter situations, you can still make the gift, but you’ll have to take the distribution, include it in your gross income, then claim the commensurate charitable deduction on your taxes. That equivalent income and deduction often results in a wash as far as taxes are concerned, but it’s not as elegant a solution as the Charitable IRA Rollover.

Of course, with any planned giving vehicle, you should seek the counsel of legal, tax, or investment advisors that are familiar with your individual situation. However, if you are 70½ or older and have a bit more than you need in your IRA, you might just find that the Charitable IRA Rollover is the right tool to give back in a most generous, and highly tax-efficient, way.

This column by Bret Bicoy originally appeared in the Peninsula Pulse on January 8, 2016.

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