Featured Savings Rates

Popular Posts

Featured Accounts

Personal CD Investing: Giving Back Through QCDs


Personal CD Investing: Giving Back Through QCDs

The following is a guest post contributed by Charles Rechlin, a long-time reader and friend of the site. His last guest post covered rate chasing. I would like to thank Charles for sharing more of his valuable experience on personal CD investing.

Notes on Personal CD Investing: Giving Back Through QCDs

by Charles Rechlin

I turned 70 in July. That’ll make me 70-1/2 next January.

Although Americans ordinarily don’t celebrate half-year birthdays or anniversaries, the IRS is an exception, at least for those crossing the 70-1/2 threshold.

For me, reaching that milestone means my traditional individual retirement account (IRA) assets will become subject to “required minimum distributions” (RMDs) under the tax code—for 2017 and every year thereafter.

Until last fall, I avoided facing up to this grim fact. Just thinking about paying taxes on my IRA assets was like imagining my contracting a dread disease—it was too awful to contemplate.

Now, at long last, I’m cobbling together a strategy to potentially eliminate (or at least minimize) taxes on my IRA assets while implementing a long-standing estate planning objective of mine—to fund educational endowments at my Alma Mater, Cornell University. All legally and above-board.

It involves taking advantage of “qualified charitable distributions” (QCDs).

Background

Currently, I maintain traditional IRA accounts at six banks, three credit unions and two online brokerage firms.

My IRA assets have been accumulated over some 37 years. They’ve been contributed, rolled over and directly transferred many times, along the way passing through multiple benefit plans, trustees and custodians.

Unfortunately, this process hasn’t cleansed them of their ultimate taxability—most will be subject to federal and state income taxes when distributed to me through RMDs. Only a small fraction of their value represents “basis”—i.e., after-tax contributions not subject to taxes on distribution.

Beginning in 2017, I’ll be subject to an obligation to take RMDs each year to avoid paying a 50% federal tax on undistributed amounts. The RMD for each of my IRA accounts will be determined by dividing the balance of that account as of December 31 of the previous year by my “life expectancy factor” as set forth in the applicable IRS table.

All taxpayers are allowed a grace period for distribution of the first year’s RMD—to April 1 of the following year.

For 2017, that means I’ll be required to distribute approximately 3.77% of the value of my IRAs as of December 31, 2016. (All taxpayers are allowed a grace period for distribution of the first year’s RMD—to April 1 of the following year (2018, in my case)—but future RMDs must be taken by December 31 of the year with respect to which the obligation arises.)

Because I have so little basis in my IRAs, and because tax rules provide that basis can only be applied to RMD payments pro rata each year, most of the RMDs taken by me for 2017 and beyond will be subject to income taxation at ordinary rates.

My Thinking About RMDs—Old and New

For many years, each of my IRA accounts has named Cornell University as my sole beneficiary, entitled to receive the account balance upon my death. Under my will—and pursuant to a long-standing understanding I’ve had with Cornell—all amounts received by the University from my estate, including my IRAs, will be applied to specific endowments at Cornell Law School.

For as long as I can remember, I’ve just assumed that I’d have to take RMDs beginning the year I turned 70-1/2, and include most of the amounts distributed in my taxable income. I figured that Cornell would have to be satisfied with whatever balances were left at the time of my death, after the IRS and the California Franchise Tax Board had taken their shares during my lifetime. (The remaining balances distributed at the time of my demise would not by subject to further income taxation or estate taxation because Cornell is a non-profit, tax-exempt institution.)

That was my old way of thinking. In truth, it wasn’t “thinking” at all.

Then, last year, I decided to start taking my IRAs and RMD obligations seriously. I actually looked for ways to distribute my IRA assets without paying taxes on them. That’s when I discovered QCDs.

Congress made QCDs a permanent part of the tax code last year.

The QCD provisions of the tax code have been around since 2006, but, until December 2015, they’d always been temporary, subject to periodic renewal by Congress, often accomplished by last-minute, year-end “extender” legislation. Because of the law’s temporary nature, and history of last-minute renewals, QCDs weren’t a particularly attractive or reliable tax or estate planning tool.

That all changed when Congress made QCDs a permanent part of the tax code last year.

How I Can Use QCDs

Under the QCD provisions of the law, a taxpayer, beginning when he or she reaches age 70-1/2, is permitted to donate to a qualifying charity or charities up to $100,000 per year out of traditional IRA assets and have that donation count toward satisfying his or her RMD for the year.

Although QCDs are not deductible as such, they operate to offset, dollar-for-dollar, the increase in adjusted gross income (AGI) that would otherwise result from taking taxable RMDs. Therefore, they don’t increase taxable income.

To qualify for this tax treatment, several conditions must be met, including, among others, the following:

  • The taxpayer must be at least 70-1/2 at the time the donation is made to the charity.
  • The charity must qualify as a 501(c)(3) organization under the tax code, and cannot be a “private foundation,” a “supporting organization” or a “donor-advised fund” (check with a tax expert if you want to know what these exclusions refer to).
  • The entire amount of the donation must be one that would otherwise qualify for a full charitable deduction—i.e., there can be no “quid pro quo” benefits for the donation, like the receipt by the taxpayer of goods or services from the charity.
  • The donation must be made by the IRA custodian directly to the charity (although apparently a check of the custodian payable to the order of the charity, sent to the taxpayer and then forwarded by him or her to the charity, will work).

Because QCDs are not reflected in a taxpayer’s AGI, they can offer a more financially attractive way of making charitable contributions than taking RMDs and making standard deductible donations.

For example, QCDs are not subject to the rule limiting charitable deductions to 50% of AGI in any one year. Further, they may avoid triggering certain unfavorable AGI-based tax consequences, such as itemized deduction reductions (“Pease Limitations”) and Medicare taxes on investment income. They also aren’t reflected in “modified adjusted gross income,” applied to determine, and potentially increase, a taxpayer’s Medicare Part B premiums. And, because they don’t result in any increase in taxable income, they don’t risk putting a taxpayer in a higher tax bracket, as RMDs may do.

Because QCDs are not reflected in a taxpayer’s AGI, they can offer a more financially attractive way of making charitable contributions than taking RMDs and making standard deductible donations.

My RMD requirements for any year will be determined by totaling up the separately-calculated RMD for each of my traditional IRA accounts. However, they may be satisfied by distributions from only one or a portion of those accounts. Similarly, I’ll be permitted to select the IRA accounts from which to make QCDs, and those QCDs will be credited against my total RMD requirements for the year.

In this regard, I’ll probably make my QCD or QCDs for 2017 entirely from brokered CDs maturing in my IRA account at Fidelity Investments, leaving my other IRA accounts untouched. Fidelity provides a form online that can be completed and mailed back to it to authorize a QCD, including its payment to the selected charity.

Conclusion (Plus Disclaimer)

I’m still working out the details of how and when I take advantage of QCDs once I turn 70-1/2.

One thing is clear, however: so long as I’m financially able to do so, I intend to use QCDs to minimize the potential tax liability associated with RMD requirements and maximize the charitable donations I can make prior to my death.

Given that I’ve lived in retirement for a number of years on the taxable interest from my non-IRA CD portfolio (paltry as that has been since 2008), plus Social Security and defined benefit plan pension payments, without having to tap into my IRA assets, perhaps I can avoid RMDs altogether, while giving back something to society in the process.

A lot will depend, of course, on Janet Yellen and the Fed. (So, what else is new?)

Now, for the disclaimer. I’m not giving tax or financial advice to readers here, just describing my own situation involving RMDs. I no longer practice law, and I’m not an expert on tax or estate planning matters. My personal situation—being single, with no immediate family or dependents—is unusual.

However, it seems to me that readers with charitable inclinations (whether expansive or modest) should look into the possible advantages of QCDs once reaching 70-1/2. As I’ve done, however, they’ll need to consult their own advisers to make sure they’re on sound footing in what they choose to do.

Comments
CapitalClimate
CapitalClimate   |     |   Comment #1
Thanks for a nice review of RMD requirements and options.
You could also hedge somewhat by reducing your RMDs with a QLAC annuity (limited to 25% or $125K of IRA total balance).

https://www.fidelity.com/viewpoints/retirement/mrds-to-retirement-income-for-life
Anonymous
Anonymous   |     |   Comment #7
Can I buy a SPIA in planning for Medicare LTC?
Anonymous
Anonymous   |     |   Comment #8
Medicaid not Medicare
Anonymous
Anonymous   |     |   Comment #15
The FEDs have created an environment where the traditional way to diversify a portfolio might not be effective should we ever experience a downturn again, reason the bonds go up or down in step with stock market, which is totally opposite of the logic and money matter.
Furthermore, the interest received on those investment are next to nothing and the cost may eat into the principle later on should you want to bail out.
Frank Walker
Frank Walker   |     |   Comment #2
Charles I'm older than you.  Appreciate your contribution here.  You have made me feel even happier than I did before to have a Roth.
ChasR
ChasR   |     |   Comment #3
I'd rather give my IRA away than distribute it piecemeal to myself, pay taxes on the pieces and earn next-to-nothing of what's left over.
Anonymous
Anonymous   |     |   Comment #5
If you are planning to give your RMD to charity, then the traditional IRA would have been the better long term route to take over a Roth. The contribution amount in a Roth is after tax contributions.

With traditional IRA's, you saved on income taxes because your taxable income was reduced by the amount of the contribution.  Now during the RMD stage, you pay no taxes on the QCD funded with the RMD.
Anonymous
Anonymous   |     |   Comment #6
And if Congress changes the rules on Roths...as they did by taxing soc sec...then u r ****ed by having a Roth...I like after tax income
Anonymous
Anonymous   |     |   Comment #4
Very nice...been taking QCD for a few years.  My big issue is whether the charity deserves the QCD...and what I mean by that is...I am very selective on donee based in large part by whether or not it promotes QCD...if it DOESN'T it must not need the money!  Look forward to comments by others
ChasR
ChasR   |     |   Comment #9
I agree that charities haven't been particularly focused on QCD giving, but perhaps you're being a bit unfair to some that haven't promoted QCDs.  In the case of Cornell, QCDs have been referred to for several years in various publications about giving, but not emphasized.  I think the reason has been that QCDs haven't been a reliable basis for planned giving until this year because they haven't been a permanent part of the tax code before.  With me, the school (as opposed to the guy in my class in charge of the annual fund drive!) has always been more interested in what I'm planning to give over the years than in what I'm going to give in any one fiscal year.  They still need the money, though.  Just a thought.
 
Bob McKenna
Bob McKenna (anonymous)   |     |   Comment #10
Nice article, as usual Charles.  We are the same ages so I can really relate.  I tithe 10% of my expenses to my church each year, out of after tax dollars.  I do not itemize deductions.  I can now see me tithing the 10% out of my IRAs each year.  This changes my use of after tax dollars to pre-tax dollars.

If I itemized this may not have been an advantage, since I could deduct 100% of my contributions up to 50% of AGI but given I take the standard deduction I see no harm to my church, but less I have to pay the IRS, which has become my "goal in life".

I have really come to look forward to your articles, and I can't wait to see what you are studying next.
ChasR
ChasR   |     |   Comment #23
Thanks.

For me, the main advantage of QCDs right now relates to the Pease deduction limitations.  When the Fed really starts ratcheting down rates (I said "when" but not "if"), perhaps to negative territory, it may help me in other ways, like Part B premiums, which hit a single taxpayer like me hard.  In any event, there's the satisfaction of keeping the IRS' hands off my money.
TAX MAN
TAX MAN (anonymous)   |     |   Comment #11
THE QCD IS NOT DEDUCTED FROM THE TOTAL RMD DISTRIBUTION--THE TOTAL RMD IS STILL FORMS THE MODIFIED ADJUSTED GROSS INCOME TO DETERMINE MEDICARE PREMIUM IRMAA {BOTTOM LINE AGI ON 1ST PAGE FRONT OF 1040}

IT IS A REDUCTION OF THE RMD WHEN IT COMES TO INCOME TAX ON THE RMD LATER IN THE TAX CALCULATION.  BUT, THE ONUS IS ON THE TAX PAYER TO DO THAT CALCULATION AND TO PROVE IT WITH THE CHARITY PAPERWORK.--THE RMD DISTRIBUTOR (BANK, BROKER, ETC.) ONLY PROVIDES A 1099R FOR THE TOTAL RMD AND IS SILENT ON THE QCD TO THE IRS---ITS ALL BETWEEN THE TAXPAYER AND THE CHARITY TO RECONCILE.

SO WATCH OUT FOR THE IRMAA ON YOUR MEDICARE PREMIUMS (HIGHER PREMIUMS FOR "HIGH EARNERS"--> NEW TABLE EACH YEAR --> COULD MAKE PREMIUMS ON PART B AND D DOUBLE TO QUADRUPLE OR BE MORE THAN YOU EVER COULD IMAGINE

YOU CANNOT DONATE YOUR WAY OUR OF THE IRS AND US GOVERNMENT FINDING WAYS TO GET THEIR "TRIBUTE"
Anonymous
Anonymous   |     |   Comment #12
WHY IS YOUR POST ALL IN CAPS?
TAX MAN
TAX MAN (anonymous)   |     |   Comment #27
I am sorry about the CAPS.  I have a sight problem and it is easier for me to type in caps  and see what I have typed.  But, I know it is irritating. 

I appreciated several of the other comments.  Coincidentally, it is FIDELITY who told me that I would receive a 1099R showing the total RMD distribution--regardless of whether I donated any or all of it to a QRD.  Furthermore, they advised me that the total RMD would have to be included on the first page in my AGI.  They did say that the tax deduction becomes a result of the charity paperwork and other areas of reporting on the IRS form.  Hence, my AGI is all that Medicare sees to raise my premiums if I am over the MAGI limits.

This was a terrific subject and I appreciate the description setting the comments in to motion.
ChasR
ChasR   |     |   Comment #28
Fidelity may not be reporting QCDs as non-taxable on 1099Rs, but I disagree that they get included in the adjusted gross income as shown on the last line of page 1 of Form 1040.  As you can see in the comment of CapitalClimate (#20), the 1040 instructions expressly state that the amount of a QCD should not be included on Line 15b, so I don't see how it can arithmetically add to the total income used in determining Line 37,which is  the number Medicare should be looking at.  Also, every tax expert I've read (financial, lawyers, accounting) seems to agree that QCDs aren't reflected in Modified AGI for Medicare Part B premium computations, and that's a potential advantage of making them.  Finally, Fidelity's own website has a statement in its discussion of QCDs that "keeping your taxable income lower may reduce the impact of certain tax credits and deductions, including Social Security and Medicare."  This is rather vague and inelegant, but my guess is Fidelity was trying to include Part B premiums in its reference to Medicare here. 

In my case, it will make no difference; I am and will stay maxed out under Part B with or without making any QCDs.  But, as I pointed out in the article, every reader should look to his or her own financial or tax adviser before going ahead with a QCD.
ChasR
ChasR   |     |   Comment #30
Thanks.  I'll go with TurboTax on this.
Anonymous
Anonymous   |     |   Comment #31
1099s will NOT show that it is a QCD...that is part of the problem...they merely show a distribution and (usually) they are not able to say whether or not taxable
ChasR
ChasR   |     |   Comment #14
QCDs are not included in "adjusted gross income" on Form 1040.  They are reported as retirement account distributions on Line 15a of the 1040 but are not included in the "taxable amount" of those distributions on Line 15b.  I have no idea whether Fidelity or any of my other custodians will report this correctly on Form 1099R, but I'm very sure I can deal with it because it's the law, particularly since the provision is now a permanent part of the tax code. 
Anonymous
Anonymous   |     |   Comment #17
I use a standard letter to the trustee and a cc to the donee...highlighting  the QCD nature, have the check payable by the trustee (usually with a FBO on it) and except for one university, i.e. one that does not promote QCDs) to the donee, all receipts acknowledge that it is a QCD for my benefit.  Otherwise the check would be from the trustee without any indication from whose account or even if from an IRA.  And, I physically pick up the check to ensure everything is in order and I deliver it to the donee
ChasR
ChasR   |     |   Comment #18
That's helpful to know.  Fidelity's form permits you to go either way--direct payment by Fidelity to the charity, or a check payable to the order of the charity sent to you for forwarding.  I'll be following up with them (as well as Cornell and Turbo Tax) on tax reporting issues before I make the contribution next year.
CapitalClimate
CapitalClimate   |     |   Comment #20
The instructions for line 15 show explicitly that the QCD is excluded from the taxable amount:

Exception 3. If the distribution is a
qualified charitable distribution (QCD),
enter the total distribution on line 15a. If
the total amount distributed is a QCD,
enter -0- on line 15b. If only part of the
distribution is a QCD, enter the part that
is not a QCD on line 15b unless Exception
2 applies to that part. Enter “QCD”
next to line 15b.
Anonymous
Anonymous   |     |   Comment #21
I also attached the letter (similar to 17 above) to the tax return with the receipt
Anonymous
Anonymous   |     |   Comment #13
very helpful and current.
#16 - This comment has been removed for violating our comment policy.
Anonymous
Anonymous   |     |   Comment #19
" Just thinking about paying taxes on my IRA assets was like imagining my contracting a dread disease—it was too awful to contemplate." Need I mention tax-deferral.

This type of planning (you are a generous man) is why there should be no tax deferrals at all. Earn, pay tax and invest as you please. Pay tax on dividends and capital gains and call it a day. Do as YOU please with the rest of your money. Oh, and employer 401K contributions should also be taxed at time of issuance. I know people who think they have a million bucks in their 401K. When I tell them they are already in the 25% bracket due to other income and that their 401K is worth 750K they argue every time.

Again, your generosity in giving is admirable!     
#22 - This comment has been removed for violating our comment policy.
#24 - This comment has been removed for violating our comment policy.