Using retirement assets for charitable purposes requires some care.
“Contribute something, whatever percentage of your salary you think you can, starting right away.”
I can still remember that advice on the first day of my first job out of college, when I was handed a form for payroll deduction to my employer’s 401(k) plan.
You may have received similar advice, and we both know why. First, taking responsibility for our own retirement is critical. No one else is going to make sure that we have adequate resources when we are no longer working, so “paying ourselves first” is great advice.
There’s another reason for that advice, though. The tax advantages of saving in a qualified retirement plan account such as a 401(k), 403(b), or Individual Retirement Account (IRA), are significant. Why? In most cases, all the money in these accounts – our contributions, our employers’ contributions, and any earnings and capital gains – is tax-deferred. During our higher earning years, we do not have to pay income tax on any of that money, leveraging all the income and growth for our retirement.
Notice, though, that I said “tax-deferred.” I did not say tax-free. Usually, income tax is paid on the portion we withdraw in retirement (or when we’re required to by law1). And at some point, income tax will be paid on every dollar in most retirement accounts either by the account holder or their heirs – except for any portion that goes to a qualified charity.
This is why IRAs and other qualified retirement accounts are often a great choice for charitable gifts. And they work for people of modest net worth as much as those of great wealth. But using retirement account assets for charitable purposes requires some care.
Let’s consider a few scenarios.
Scenario 1: Linda, Age 65
Linda wants to make a $10,000 contribution to her local food bank. She has more money in her IRA than she anticipates needing, so she would like to use funds from that account for the gift.
This probably isn’t a good idea. Linda will be taxed on the $10,000 withdrawal from her IRA, creating taxable income she doesn’t need. If she itemizes deductions on her income tax return, the gift may qualify for a charitable deduction, but she might be financially better off using other assets, such as other cash or appreciated securities.
Scenario 2: Willis, Age 78
Willis wants to make a $50,000 contribution to his church to assist with repairs to their aging building. He is considering taking extra money from his IRA on top of his required minimum distribution (RMD) to make the gift.
Great idea! Just be deliberate in how you do this, Willis. Since Willis is more than 70 ½ years old, he is allowed to make qualified charitable distributions (QCDs)2 from his IRA directly to charity. (That money cannot be paid to him first; it must go straight from the IRA to the organization.) Donors may make QCDs up to a maximum total of $100,000 per year without claiming those funds as taxable income. And, those withdrawals count toward the donor’s RMD, turning what would otherwise be Willis’s taxable income into tax-exempt funding for his church.
A QCD, however, does not qualify for an income-tax deduction, because the funds were never subject to income tax. If Willis’s income, including his RMD, is modest and he has other assets like appreciated securities, he might consider using those to fund his donation to his church. In either case, he should consult with his tax advisor before making the gift.
Scenario 3: Maliq, Widower
Maliq is revising his estate plans. His wife died a year ago, and he wants to honor her with a named endowment fund at the animal shelter where she volunteered. He would also like to leave a modest amount to the hospice organization that provided her end-of-life care. The remainder of his estate will go to his grown daughter. In addition to his home, Maliq’s primary assets are a portfolio of appreciated securities and his IRA account. His total estate value falls below the threshold for federal and state estate tax liability.
Assuming the values of Maliq’s stock portfolio and IRA work for his objectives, he should name the animal shelter and hospice as payable-on-death beneficiaries of his IRA and leave the appreciated securities for his daughter. Why? If his daughter inherits the IRA, she will be required to pay income tax on the full amount, or she can take distributions over a period of years not to exceed ten and pay tax on those annual distributions. The animal shelter and hospice are tax-exempt organizations, however, so if they receive the IRA funds, it preserves the full value to be used for their work.
Additionally, Maliq’s securities will benefit from a “step-up” in basis to the value on his date of death, meaning they will pass to his daughter without any taxable gain. This way, all of Maliq’s financial assets maintain their full value for his beneficiaries.
Conclusion: IRAs can be awesome for your giving.
In many circumstances, IRAs and other retirement plan accounts can provide funds for tax-savvy philanthropy, especially as part of one’s overall estate plan. Of course, whenever you are considering a substantial charitable contribution, you should do so within the context of your overall financial objectives and speak with qualified tax, financial, and legal advisors.
1As of January 2023, taxpayers are required to begin distributions from their qualified retirement accounts at the following ages.
|Birth Year||Age to Begin RMDs|
|Before 1949||70 1/2|
|1949 – 1950||72|
|1951 – 1959||73|
|1960 or later||75|
2Qualified charitable distributions are allowed from IRAs directly to qualified charitable organizations, as defined in the tax code, excluding private foundations, donor advised funds, and supporting organizations. Donors may not receive any benefits from these distributions. Donors should consult with the intended charitable recipient to make certain they qualify.
The SECURE 2.0 Act of 2022, signed into law on December 29, 2022 as part of the Consolidated Appropriations Act, 2023, provides for qualified charitable distributions to charitable gift annuities and charitable remainder trusts with additional limitations. Contact the author of this article at firstname.lastname@example.org or your financial or tax advisor to learn more.
Disclaimer: This information is not intended as legal, tax, or financial planning advice. Readers should consult with their own professional advisors before making any charitable gift.