IRA-to-charity rollovers are a smart move for retirees

January 21, 2011

A bird flies past a couple sitting on the beach in Rehoboth, Deleware, September 10, 2010.  REUTERS/Jim Young  Since 2006, a popular tax rule had permitted those aged 70-and-a-half or older to donate up to $100,000 from their Individual Retirement Accounts to charity. Last year, as the tax flux dragged on, no one knew whether this provision would stay or go.

At the 11th hour, the December tax legislation gave it the okay: The provision was both extended through the end of 2011 and permitted retroactively for 2010. Given the delays, the deadline to do this and have it count for 2010 has been pushed out till Jan. 31. If you’ve got the funds and it makes financial sense, you could make two IRA-to-charity rollovers this year, counting one donation for 2010 and one for 2011.

For last year’s contribution, unfortunately, you need to have forgone your required minimum distributions (RMDs) for the year. If you already took them, sorry, you’re out of luck: The Internal Revenue Service won’t let you return those payments in order to take advantage of this charitable rollover for 2010.

“It’s a hot topic here,” says Craig Richards,” director of tax services at Fiduciary Trust International. “Unfortunately, none of our clients so far have been able to take advantage of it for 2010 because we got such late tax legislation.”

But even if that’s the case, it’s worth considering for 2011. And that’s the case even if your retirement funds, and your charitable donations, are relatively modest.

What’s the big deal? For those who don’t need all their RMDs for living expenses — or for those who were going to give money to charity, anyway — this can be a very savvy financial play. That’s because the charitable rollover can count toward the RMD amount, but is not taxed as a regular distribution would be. While you don’t get the charitable tax break, it’s a better deal than taking the RMD, paying tax, and then giving the money to charity.

Consider a simplified example: If you gave $100,000 from your IRA to charity through this rollover, the charity would get $100,000 and you’d pay no tax. If you took the $100,000 as an RMD and paid tax on it at the 35 percent tax bracket, you’d have only $65,000 left to give to charity. You’d get a tax benefit of $22,750 for donating that smaller amount. But overall, you’d end up with a net tax payment of $12,250 on a much-lower charitable donation.

While it’s great if you’ve got enough funds to give all $100,000, even for smaller donations — $1,000, say, or $5,000 — this is a smart move.  For example, if you use the money taken out of your IRA through RMDs to live off, but make charitable contributions with other funds, you’ll get a better deal if you did those donations through this direct rollover, and reduced your RMDs accordingly. It’s an especially valuable move for those who don’t itemize on their returns (Florida retirees, perhaps, who pay no state income tax), and would otherwise get no tax benefit for the charitable contribution.

“In my little world we think of this for the big hitters, but it can work for anybody with charitable intention,” Richards says. “If you have a small IRA, and were going to give $10,000 to the Red Cross regardless of what you take out of it, you are never going to do any better than this. I can see this working for the little guy who might not even be aware of the fact that this rule exists.”

Of course, it’s a pretty great thing for charities, too, which have been marketing the opportunity like mad since the tax legislation passed.

If you’re looking at doing this for 2011, there’s no rush to do the rollover. It generally makes sense to let the cash compound tax-free in your IRA as long as possible. That would mean you’d do this late in the year rather than taking your RMDs.

Like all things tax, there are a few other caveats. You must make the contributions directly to a public charity (not through a foundation or donor-advised fund), and you can only take advantage of this move with your IRA, not your 401(k) plan.

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