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Required Minimum Distributions: Savings through Charitable Contributions

retirement planning

Required Minimum Distributions (RMDs)

If you are a taxpayer over the age of 70½ years old, you are required to take distributions from your qualified plans and/or IRAs by April 1 of the year after the year you turned 70½. This requirement exists to ensure that taxpayers take the money invested in these accounts during their lifetimes (or the lifetimes of the taxpayer and spouse) so that these assets are not left to the next generation tax-deferred. Taxpayers who do not take the RMDs must pay a 50 percent excise tax on the amount required to be but not taken.

Effect on Taxable Income

An important impact of taking your RMDs is that they are taxable, which increases your taxable income. Many taxpayers may not need the full required minimum distribution (RMD) but will be required to take it or pay the excise tax. For many of these taxpayers, such a distribution will mean paying income taxes above what would have been required without the RMD.

Example #1: Single taxpayer Jane Doe receives $30,000 in Social Security benefits and another $10,000 in tax-exempt interest. At 70½, she is now required to take a minimum distribution of $40,000, increasing her total income to $80,000. In this case, Ms. Doe’s tax bill would be $7,954, with a part of the income in the 22 percent bracket ([85% * $30,000] + $40,000 = $65,500 – $12,000 [standard deduction] = $53,500 at a high of 22% = $7,954).

Example #2: If Ms. Doe is charitably inclined, the tax law provides options. Taxpayers can direct up to $100,000 of their distributions from qualified plans to a charity, and that amount will not be included in the taxpayers’ taxable income. To qualify, the distribution must be from an individual retirement plan with the following conditions. The distribution must be:

  • Made directly by the trustee to an organization
  • Made from an account of which the holder is over the age of 70½
  • Made to a charitable organization that is not a supporting organization, private foundation, or donor-advised fund
  • Made in an amount that is less than $100,000
  • Made from funds that would have been included in gross income without this provision

If Ms. Doe donates half of the RMD to a charity, her taxes in this case would be $3,829, with the tax rate only at a high of 12 percent ([85% * $30,000] + $20,000 = $45,500 – $12,000 = $33,500 at a high of 12% = $3,829). This $20,000 donation only costs Ms. Doe $16,000.

While in reality there is no deduction for such a contribution, the income is excluded from the taxpayer’s taxes. Thus, the net effect is a 100 percent deduction.

Example #3: Joe Smith is over the age of 70½, is married, and intends to make a $20,000 donation to a charity. He is required to take $30,000 from his IRA. He can take the distribution from the IRA and make the charitable deduction himself or direct that the IRA pay $20,000 to the charity and $10,000 to himself.

Under the first option, Mr. Smith will have $30,000 in taxable income. If the $20,000 donation is his only itemized deduction, then Mr. Smith would take the standard deduction and receive no tax help for the donation. The taxable income would be $600 ($30,000 – $24,000 = $6,000 * 10% tax rate). His net amount at the end of the day would be $9,400.

Alternatively, if Mr. Smith directs the IRA to pay directly to the charity, he would have zero tax liability ($10,000-$24,000) and a net at the end of the day of $10,000. Multiply these numbers and the savings become obvious.

For More Information

Prior to taking your RMD this year and making your year-end charitable contributions, you may want to seek advice from your LaPorte tax advisor and determine how much you may be able to save.