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The IRA Tax Break Retirees Need To Know About Now

By Matthew J. Curfman, CFP®
President & Co-Owner, Richmond Brothers, Inc.

(April 30, 2020 11:03 AM) Lower your taxable income while at the same time doing good for others? This may sound too good to be true, but I assure you this isn’t! Not only is this win-win situation legal, but it could also save you thousands in taxes every year. In addition, while required minimum distributions (RMDs) in 2020 are currently waived under the CARES Act, many charities and nonprofits are in need of support during the COVID-19 pandemic.

Let’s look at an example of how a seldom-used break in the tax code could benefit you or someone you know. We recently worked with a retired couple, Steve and Sharon. These two live on their school-teacher pensions, Social Security, and have about $500,000 between their IRA accounts. They just turned 72 and while they do not need to take any funds from their IRAs to supplement their income, Uncle Sam now requires them to take required minimum distributions (RMDs) out of their IRA balances due to their ages. So how can this government requirement be more efficiently put to work?

Steve and Sharon have a combined RMD of $19,532 for the current year. If you’re not familiar with RMDs, this amount is added on top of their pension and Social Security income for the year, which then can subject a larger portion of their Social Security check to taxes, as well. It’s also important to note that missing your RMD for a year could result in a tax penalty of half of the RMD you didn’t take. Yes, that’s right, missed RMDs carry a 50% penalty. Ouch.

After talking with Steve and Sharon a bit more about their situation, we found out that they are also very generous in supporting their church; they typically give $500 each month to their church. As you’re probably painfully aware, recent tax law changes make those who use the standard deduction ineligible to deduct this charitable contribution from their income taxes.

Just to drive the point home, recall the 2020 standard deduction amounts: Married, filing jointly — $24,800; Single filers — $12,400; Head of household — $18,650.

For those 65 and older, or the blind, take the standard deduction and add: Married, filing jointly — $1,300; Single filers — $1,650.

So, unless the amount of charitable donations and other itemized deductions rises to the married filing jointly levels, Steve and Sharon aren’t getting a tax break for their donations.

One way for Steve and Sharon to lessen their tax burden and continue making an impact on their church is to stop making that monthly donation from their bank account (yes, you read that right). Instead, they could make those payments directly from their IRAs, using their RMD payment for something called a qualified charitable distribution, or QCD.

If Steve and Sharon wanted to take advantage of this, what could that look like? First, using a QCD, they could transfer $6,000 directly to their church instead of their past monthly contributions. That $6,000 comes “off the top” of the $19,532 RMD for tax purposes — that is to say, that’s $6,000 they will never have to pay taxes on. Now, Steve and Sharon’s RMD taxable income will be $13,532 instead of $19,532, and they are still able to donate $6,000 to their church.

Not only do QCDs help to cut taxes, but they can also help you keep your adjusted gross income lower. You may be able to increase your medical deductions, lower your Medicare premiums, increase rental real estate losses and qualify for the Qualified Business Income deduction (self-employed business owners), among other things.

The Tax Cuts and Jobs Act of 2017 didn’t change QCDs and the way they work, but because of the higher standard deductions, it did make them that much more valuable as a tool for a tax deduction.

So, how can you deploy this strategy? Like anything else when it comes to taxes, there are lots of rules you need to follow carefully. Working with a qualified professional can ensure you navigate the rules correctly and don’t inadvertently disqualify yourself for this amazing tax break.

The QCD is for those age 70½ and older who own traditional IRAs with RMDs or beneficiary IRAs. If someone is younger or has a need for their full RMD for regular income, this wouldn’t be advantageous. Also, since Roth IRAs don’t have RMDs, a Roth wouldn’t apply in this tax situation. QCDs are allowed by IRA owners who are 70½ or older even though RMDs are not required until age 72.

You can donate up to $100,000 per IRA owner per year, regardless of your RMD. But — here’s where it’s important to work with a financial professional who is in the know — there are certain requirements for what not-for-profit agencies you can donate to through this strategy. For example, donor-advised funds and private foundations do not qualify.

You have to pay the money directly from the IRA to the charity. Otherwise, the transfer will not qualify as a QCD and will be taxed as income. This also means that, for any RMDs you have already taken, you can’t use this strategy. If the money went into your bank account or a third party or made out to you as a check, it won’t qualify as a QCD — you can certainly still donate that money, but it won’t be as tax advantageous assuming you are using the standard deduction as above.

There is no 1099-R code for QCDs; you and your tax preparer must prove the QCD. To go back to Steve and Sharon and further explain this, let’s look at what their tax season would look like if they do a $6,000 QCD. They get their 1099 statement from their IRA custodian, and it says they withdrew $19,532 from the IRA, no mention of the QCD. If Steve and Sharon have been working with financial and tax professionals who are worth their salt, however, they will have diligently recorded the transaction to their church and kept the receipts. So, when their CPA pulls together their tax documentation, it will reflect that they fulfilled their RMD on their 1099 and that $6,000 of their RMD was tax-exempt via the QCD to their church.

The QCD, when done right, is tantamount to having your cake and eating it, too. You want to fulfill your government-mandated minimum withdrawal? Check. You want to avoid having your RMD jack up your tax bill? Check. You want to donate to a cause you are passionate about? Check.

These caveats are a reminder that, particularly when it comes to your finances, income, and taxes, you don’t want to be going it alone — you want a second set of eyes and expertise that can keep more of your money in your pocket.

About the author: Matthew Curfman’s (CFP) personal mission is to help people maintain, use, and grow their wealth so that they may pay it forward to their family, friends, and communities. As a member of Ed Slott’s Master Elite IRA Advisor Group for the past decade, Matt lives out Richmond Brothers’ core value of pursuing growth and continuous learning. With focuses on retirement fund allocation and private equity, Richmond Brothers provides independent, customized investment advice to people from all walks of life. For more information visit www.richmondbrothers.com. Richmond Brothers, Inc. is an SEC-registered investment adviser and encourages all to seek professional tax and investment advice to ensure proper use of any content provided. Individual circumstances may have significant impact.

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