By Andy Ives, CFP®, AIF®
As we gradually peel back the layers of this legislative onion called the SECURE Act, more and more discoveries come to light. One revelation is how qualified charitable distributions (QCDs) are potentially affected. Could a QCD become, effectively, a taxable distribution? A looming cloud could soon peer over the shoulders of otherwise generous and giving individuals.
As a reminder, QCDs can be done by IRA owners (and inherited IRA owners) who are age 70½ or older. (The SECURE Act raised the age of RMDs to 72. However, the Act did not increase the age for QCDs – 70½ is the status quo.) IRA assets are transferred directly from an IRA to an eligible charity, and the dollar amount of the QCD is excluded from the account owner’s taxable income up to a maximum of $100,000 annually. Oftentimes, QCDs are leveraged to offset all or portion of a person’s required minimum distribution.
Yes, QCDs are a great planning tool…but the next layer of this onion stinks.
The SECURE Act also eliminated the 70½ age restriction for making deductible contributions to an IRA. Starting January 1, 2020, anyone with earned income, regardless of age, can contribute to a traditional IRA. That, in and of itself, is not bad. But what happens when a person over age 70½ combines a deductible IRA contribution with a QCD? Lousy things.
For example, Richard is 76 and still works part time. Since the SECURE Act eliminated the age restriction on traditional IRA contributions, Richard decides to make a deductible contribution of $7,000 to his IRA. Richard is also a charitable person and, in the same year as his contribution, he does a QCD for $10,000. The IRS views this as double-dipping. Richard cannot combine both the $7,000 deductible contribution and the $10,000 tax-free QCD. His otherwise tax-free QCD is reduced by the contribution amount, essentially causing $7,000 of his $10,000 QCD to be taxable.
Disregard the complicated formula provided by the SECURE Act in these situations. Just know that every post-70½ deductible IRA contribution is remembered by the IRS. These annual post-70½ contributions are tallied and totaled. The aggregate follows the IRA owner, ready to spring from the shadows and cancel the tax benefits of a future QCD.
In another example, Molly is 72 and works part-time as an organist at the local church. She makes a newly permitted $5,000 deductible contribution to her traditional IRA. Molly repeats this same transaction every year until she is 80 when she officially retires. Eight annual post-70½ deductible contributions of $5,000 have gone into her IRA totaling $40,000.
Molly has never done a QCD. When she is 85, she decides it is time to give back and requests a $50,000 QCD be directed to her church. There is a rumbling in the dark. Molly’s previous deductible contributions of $40,000, preserved by the IRS and lying dormant in a carry-forward bucket, spring forward and consume an equal amount of the QCD. In the end, $40,000 of Molly’s $50,000 QCD becomes taxable, and only $10,000 is excluded from her income for the year.
Those who itemize their taxes may find a fix. But if you take the standard deduction, is there a workaround? Not within a traditional IRA there isn’t – but other options exist. Avoid this rotten post-70½ onion altogether and simply contribute to a Roth.