Chase Mouchet, CFP®, CIMA® | Wealth Advisor
Retirees who are generous with their wealth may be facing an important question about their charitable strategy during their post-working years: Now that I’m retired, how do I fund my charitable giving?
During their accumulation years, many givers earmark a portion of their cash earnings for charitable purposes. But how should retirees think about generating income for charitable purposes when their cash flow comes from multiple income sources such as Social Security, pensions, deferred compensation plans, or Required Minimum Distributions (RMDs)?
Fortunately, many retirees who invested for years in their workplace retirement plan can use those same funds to support their charitable giving. Current law allows individuals over age 70 ½ to direct up to $100,000 each year from their IRA to qualified charitable organizations. These charitable rollovers, also known as Qualified Charitable Distributions (QCDs), can fulfill part or possibly all of their annual RMDs. While retirees do not receive a tax deduction for QCDs, withdrawals are exempt from income taxes.
Here are four main reasons why you could be well suited to fund your charitable giving from your IRA in retirement:
Pre-tax IRA money makes up a sizable portion of your financial assets.
The money that you contributed on a pre-tax basis to your retirement plan, such as a 401(k), during your working years will eventually get taxed as ordinary income, either by taking distributions during your lifetime or finally to your heirs. However, a QCD results in a tax-free distribution of money that would have otherwise been taxed. This strategy is a huge win-win for the account holder and the charity!
You may not need the total amount of your Required Minimum Distributions for living expenses.
Account holders must use the IRS life expectancy tables to calculate how much they need to distribute from their IRA each year. Some people may not need all of their RMD or may have other income-producing assets such as a taxable brokerage account, real estate, or business. Therefore, recognizing less ordinary income by taking a QCD could save thousands of dollars in taxes.
You take the standard deduction instead of itemizing deductions.
The Tax Cuts and Jobs Act that became law in 2018 essentially doubled the standard deduction, resulting in a significant reduction in the number of taxpayers itemizing their deductions. Besides receiving a $300 above-the-line deduction in 2021 ($600 for joint filers), donors who take the standard deduction do not receive a tax benefit for their giving since the standard deduction exceeds their combined itemized deductions.
However, these taxpayers can lower their Adjusted Gross Income since they don’t recognize the QCD as income, which could help with tax consequences related to Medicare premiums and Social Security. It’s important though to work with a tax professional who can provide guidance on the tax benefits of QCDs, especially those who may have the opportunity to otherwise itemize.
You have already earmarked your IRA to go to charity as part of your legacy planning.
People who have supported a particular charitable organization for years may desire to continue their commitment and leave a lasting legacy after their passing. Donating money from traditional IRAs remains one of the most tax-efficient ways for people to leave money for their favorite charities after their death, partly because there will be a looming tax bill due if the heirs inherit the account.
The tax impact of leaving a traditional IRA to heirs is even less favorable now due to a SECURE Act rule that became effective in 2020. Except in a few unique circumstances, non-spouse beneficiaries must withdraw the entire balance of the retirement plan by the end of the tenth year following the account owner's death. Beneficiaries could end up being in a higher marginal tax bracket due to recognizing more income sooner. By naming a charitable organization or a donor-advised fund as an IRA beneficiary, the charity, as a tax-exempt organization, will pay no income taxes on these funds.