For charitably inclined older Americans legally required to take money out of their individual retirement accounts, the next two years - actually, the next 16 months - offer a window of opportunity.
And the time to start taking advantage of it is now.
Thanks to one of the many provisions in the Pension Protection Act signed into law in August- a provision that could easily escape attention in the massive, 900-plus-page legislation - IRA holders 70 1/2 and older can now transfer tax-free up to $100,000 a year from the IRA to a charity.
This part of the law, effective immediately, expires after the 2007 tax year. Unless extended, it can be used only in 2006 and 2007. The deadline for 2006 is Dec. 31.
“Better move fast on this one,” advised Ed Slott, a certified public accountant in Rockville Center, N.Y., and editor of a national newsletter on IRAs.
Although transfers from Roth IRAs also are permitted, the legislation primarily benefits taxpayers required to make annual taxable withdrawals from traditional IRAs. Under long-standing law, owners of traditional IRAs must start taking required minimum distributions after age 70 1/2 and pay taxes on those distributions.
True, IRA holders could always give the money to charity after withdrawing it from their accounts. In the case of deductible traditional IRAs, they would have to report the amount withdrawn as income in their tax returns. Then they could claim a tax deduction on the charitable contribution, making the whole transaction seemingly a wash.
But it isn’t that simple. For starters, gifts to charity can be deducted only by taxpayers who itemize deductions, and only about a third do. Itemizing yields no tax savings unless the itemized deductions exceed the standard deduction.
Also, having to report the amount withdrawn from the IRA as income, even when a charitable deduction for the same amount is taken, could lead to higher taxes on a retiree’s Social Security benefits and the loss of eligibility for certain tax breaks that are based on adjusted gross income rather than taxable income. Adjusted gross income is income before deductions and exemptions are claimed.
The new law eliminates these problems.
“The big incentive here is that the charitable donation from your IRA will satisfy your required minimum distribution” but without having to report the distribution as income, Slott said. “This can lower your income and maybe even cut down the tax you pay on Social Security income, not to mention the loss of tax deductions, exemptions and tax credits that are lost when your (adjusted gross) income is increased.”
On top of that, preparing your tax return will be simpler than if you had to report the income from the IRA distribution and then claim a charitable donation. Transferring the money directly from an IRA to a charity “will be favored by many major donors and their tax advisers to simplify taxes and keep income levels lower,’” said Michael Zmistowski, principal of First Gulf Advisors in Tampa, Fla. who estimates that charitable gifts from IRAs could reach $1 billion or more in 2006 and 2007.
Bottom line: If you normally make charitable donations, consider making those donations from your IRA now if you qualify under the new law. If you do not itemize deductions - many retirees with a paid-up mortgage don’t - you’ll enjoy the added benefit of lowering your taxable income and total tax bill.
Now for some caveats. The new legislation applies only to gifts to public charities, not private foundations, donor-advised funds or charitable gift annuities. The money has to be transferred directly from the IRA to the charity without you ever laying hands on it.
“IRA owners should contact their IRA custodian to direct transfers to qualified public charities,” Zmistowski said. The specific transfer and reporting forms will be determined by the IRA custodian and the U.S. Treasury.
Humberto and Georgina Cruz are a husband-and-wife writing team who work together in this column.
Send questions and comments to AskHumberto@aol.com or