Tuesday March 28, 2023
Case of the Week
Gifts from IRAs, Part 11
Case:Quentin Charles Douglas was the firstborn child in a large family. Throughout his childhood, Quentin's parents worked hard to put food on the table for their children. They also instilled in Quentin the value of hard work and saving money. Quentin took those lessons to heart, putting forth his best effort in school, finding a rewarding job and putting away as much in savings as he could. For many years, Quentin worked for a company that offered a 401(k) plan. During those years, he put as much into his 401(k) as he could afford so that he could maximize the benefit of his employer's matching contributions. Eventually, Quentin moved on to other employment and made a tax-free rollover of his 401(k) into an IRA. As he approached retirement, Quentin continued to contribute to his retirement savings by maxing out his IRA contributions each year. With his lifelong penchant for saving money and some savvy investing, Quentin was able to retire comfortably at age 65. Now, a few years later, Quentin accepted a job doing what he loved. With this new job, he would like to continue to add to his traditional IRA even though he has reached age 72. He understands that he can make tax deductible contributions to his IRA, if he has taxable compensation. Quentin's required minimum distributions (RMDs) from his IRA have started. Given his lifetime savings, investment income and social security distributions, Quentin does not feel as though he needs the additional income that the IRA distributions will provide – especially with the increased taxes tied to that income.
Question:Quentin would like to make tax-deductible contributions to his IRA. These tax-deductible contributions to his IRA will lower his taxable income while he is working. Quentin wondered if he could also use his IRA qualified charitable distribution (QCD) to lower his taxable income in the same year. After speaking with his advisor, Quentin discovered that any post-age 70½ contributions to his traditional IRA will reduce the amount of his QCD (see Part 9), but that post-age 70½ contributions to a Roth IRA will not reduce the amount of his QCD (see Part 10). However, Quentin has already begun to make contributions to his traditional IRA. He responds to his advisor to ask if there are other options since he had already made post-age 70½ contributions.
Solution:After learning that tax-deductible IRA contributions after age 70½ will reduce his ability for QCD treatment on his IRA charitable rollover gifts, Quentin receives an answer from his advisor on potential alternate options. Quentin may be able to withdraw the post-age 70½ IRA contribution. This is a time sensitive withdrawal and may not be available for prior year contributions. If Quentin had a significant amount of contributions after 70½, he could accelerate the recapture by taking a distribution up to the value of the cumulative post-age 70½ tax deductible IRA contributions. Quentin would be able to contribute the cash proceeds to a nonprofit and claim an itemized deduction. The itemized deduction may offset the taxable income from the distribution, subject to the cash deduction limit of 60% of the donor's adjusted gross income (AGI). Moving forward with this election, Quentin will want to consider the tax implications for a large taxable distribution from his IRA to ensure that the income tax implications will be what he intends. In order to meet the deduction limit of 60% of the donor's AGI, he will need to consider his expected income both prior to and after the IRA distribution. For example, Quentin expects to reach $75,000 in AGI. If he takes a $15,000 distribution from his IRA, he will increase his AGI by the value of his distribution. In order to reach the 60% of AGI charitable deduction, Quentin will need to make a cash gift of $54,000. Quentin is very glad he reached out to his advisor to understand how his IRA contributions impact the tax treatment of his QCDs.
Published September 16, 2022