Use Retirement RMDs and Non Qualified Assets to Cut Taxes and Support Charities

At year-end, many investors focus on gifting strategies that enable them to reduce taxable income, rebalance portfolios and fulfill philanthropic goals. Two different scenarios may help you achieve all these goals with your qualified and non-qualified investment accounts.

Qualified Accounts

Qualified accounts are those that are designated as retirement savings and are tax-advantaged, offering deferred taxation on contributions and tax-free growth during the years before distributions are started. They include 401(k) plans, Individual Retirement Accounts (IRAs) and retirement accounts geared toward the self-employed.

Most retirement savers, once they reach ages 73 to 75, are subject to annual Required Minimum Distributions (RMDs), meaning they must start making yearly withdrawals of minimum amounts based on their balances. Some retirees, however, have plenty of resources to live on and don’t necessarily want to take these RMDs. Above all, they don’t want to pay the federal and state income taxes levied on retirement plan distributions.

Qualified Charitable Distribution

An attractive option for IRA owners is to make a Qualified Charitable Distribution (QCD), which fulfills the RMD requirement and facilitates a tax-advantaged donation to a qualified charity.

(It’s important to note that QCDs are available only to IRA owners, and not holders of other types of retirement accounts.)

The advantages of QCDs include:

Rules Governing QCDs

There are strict rules governing how QCDs are made, so you should work with an investment or tax advisor before deciding whether to make a QCD.

  • You, as the IRA owner, never “touch” the money that is used for a QCD. You must contact the IRA custodian (i.e., Morgan Stanley, Schwab, Vanguard) and request a QCD, providing the designated charity’s name, address and EIN. The IRA custodian will then disburse the funds directly to your chosen charity.
  • A QCD must be made before an RMD if you want it to offset the RMD.
  • You must be at least 70½ years of age as of the date the QCD transfer is made.
  • The QCD must clear by December 31, and different IRA custodians may process them differently, so requesting the QCD at least four to six weeks in advance is a good practice.

A Word of Caution: Form 1099-R

Some investors make both a QCD and a standard RMD. Say your total RMD is $50,000. You may decide to divert $30,000 to the QCD and take the remaining $20,000 as a taxable RMD.

If you do this, the Form 1099-R you receive from the IRA custodian may not distinguish between the QCD and the RMD, meaning you could be taxed on the full amount, or the full amount would be treated as a QCD. Either scenario would cause a tax headache. So, work with a tax advisor who is experienced at dealing with QCDs and problems with the Form 1099-R.

QCDs: Why Wait?

If you are inclined to make a QCD, you need not wait until the end of the year to do it. Charities would love to receive your contributions at any time of the year. In fact, since most nonprofits have a June 30 year-end, making donations and QCDs in the spring is helpful to them because they can factor your philanthropy into their budgets for the next fiscal year.

Non-Qualified Accounts

Non-qualified accounts are those that are funded with after-tax dollars and don’t receive the tax advantages that apply to retirement accounts. These include brokerage accounts, investment accounts and trust accounts, among others.

The goal with non-qualified accounts is to rebalance portfolios while reducing exposure to capital gains taxes. One tax-savvy way to do that is to gift highly appreciated shares to a qualified nonprofit organization.

If you have highly appreciated shares in your portfolio that you need to trim, gifting those shares to a qualified nonprofit enables you to avoid capital gains taxes because you are not selling the shares. You donate the shares through an “in-kind transfer,” which delivers the shares to the designated nonprofit without liquidating them. The shares are transferred from your account directly to the nonprofit’s investment account. When the nonprofit sells the shares, there is no tax liability.

This strategy works well for investors who need to rebalance their portfolios and trim certain overweighted sectors. Certain sectors, including technology, have grown so much in the past few years, gifting tech shares has become common among investors who hold these positions.

Advantages of Gifting Highly Appreciated Shares

If an investor is in the 37% tax bracket and also is drawing RMDs, which are taxable, then subsequently writing checks to donate to charity, they’re effectively reducing their donation by 37% because of the taxes they are paying on the RMDs. By gifting appreciated shares, they can effectively donate 37% more to charity that otherwise would have gone to the IRS.

Questions?

Investors who seek to use either of these strategies — QCDs or donations of appreciated shares — will benefit from working with a team that includes both investment and tax advisors. If you would like to discuss these and other tax-savvy strategies, contact an Adams Brown Wealth Consultant.