IRAs and qualified retirement plans like 401(k)s, 403(b)s, and 457(b)s are among the most tax-inefficient assets to leave your heirs.  Distributions from IRAs and qualified retirement accounts are taxed as ordinary income and can be taxed up to the highest marginal income tax rates.  For wealthy taxpayers, their IRA balances may be subject to the estate tax at 40%.  At their death, if the beneficiaries they have named are subject to the highest (39.6%) income tax bracket, the amount received by the next generation from the inherited IRA account may be only thirty-six cents on the dollar. 

Fortunately, there is a strategy available that will help taxpayers avoid the estate tax and income tax consequences that result if they die with large balances in their IRA accounts.

If you are currently making charitable contributions and/or have plans to leave some of your wealth to charities at death, you can begin making charitable donations directly from your IRA.  The Protecting Americans from Tax Hikes (PATH) Act, passed on December 18, 2015, provides for a Qualified Charitable Distribution (QCD).  Simply put, an individual who is at least 70.5 years-old may distribute money from their IRA to a charity.  This distribution removes money from the IRA without any income tax consequences to the individual.  It reduces the individual’s taxable estate and it fulfills the individual’s Required Minimum Distribution (RMD) for the year.

The following elements must exist in order for the distribution to meet the requirements of being a QCD:

  1. The IRA owner must be at least 70.5 years-old at the time the distribution is made;
  2. No more than $100,000 can be distributed to charity in a calendar year from the IRA;
  3. The distribution(s) must be made directly to the charity(ies).

Assuming the above requirements are met, an individual with an RMD of less than $100,000 can use the QCD to cover the entire amount required to be distributed.  If the RMD is greater than $100,000, then the QCD can be used to cover up to $100,000 of the amount required to be distributed.  For many individuals, avoiding the income from an IRA distribution is a greater tax benefit than the charitable deduction available by making an after-tax donation to a charity.

If a QCD is used, there is no income to report by the IRA beneficiary related to the distribution on his or her income tax return.  However, the amount that was distributed to charity will also not be deductible on the income tax return as a charitable contribution.

While naming a charity as a beneficiary of an IRA has been a smart tax-planning strategy for many years, the ability to gift money out of IRA accounts to charities during one’s lifetime has been an intermittent opportunity.  With the passing of the PATH Act, it appears that the QCD strategy should be available for many years to come.

If you would like to discuss the applicability of the QCD strategy to your family’s specific situation, we would welcome the conversation.

This update is intended for the use of Oak Wealth Advisors LLC clients.  This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC.  Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.