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).
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.
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.
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.
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.