Strict rules govern early IRA distributions

Even for qualified charitable benefit, year turning 70½ is the allowable time to begin pulling out funds

Q: I will turn 70½ in 2016 and will have to start taking distributions from my IRA. I would like to take advantage of the qualified charitable distribution benefit, where the distribution is made directly to a charity. It is my understanding that I won’t have to report any income if I go that route. My question is whether I can give more than $100,000 to a charity in 2017 under this provision if I wait to take my 2016 distribution until 2017. So, if I were to take a $120,000 2017 distribution and half of that was my required 2016 distribution and half was my required 2017 distribution, could I transfer $120,000 to the charity in 2017?

The answer is no, you cannot do that. Let me take this step by step so as to try to help everyone follow the answer.

First, an IRA owner must begin taking required minimum distributions for the year in which he turns age 70½. But, for the first year RMD only, the owner may choose to defer the RMD until April 1 of the year after attaining age 70½.

So you could defer taking the 2016 RMD until April 1, 2017. If you choose to do that, you must also take the 2017 RMD by the end of 2017. You then end up with two distributions in one year.

Deferring income is usually a good thing. But bunching two distributions in one year, particularly the size that you are suggesting, could lead to a higher overall tax.

Second, an IRA owner who has reached age 70½ has the ability to make a qualified charitable distribution. If done properly, the QCD is not included in the owner’s income and no charitable deduction is claimed.

The QCD avoids inflating the owner’s adjusted gross income. The alternative is taking a distribution and then donating that distribution to charity. This often creates an offsetting deduction equal to the reported income, but it increases AGI and can cause other tax benefits to be lost.

This is so because Congress has enacted various provisions that either impose a surtax on “high-income” people or cause high-income people to lose deductions. High income is usually defined by reference to AGI.

The QCD helps the highincome taxpayer by holding the AGI down and thereby avoiding or minimizing the effects of provisions that would otherwise penalize that person.

A QCD has several qualifications. It must be paid directly to the (qualified) charity. The IRA owner must be age 70½. Finally, the QCD cannot exceed $100,000 for the year.

So even if you defer the 2016 distribution to 2017, it does not increase the amount that can be directed to a QCD. The $100,000 annual limit still applies.

If you want to donate $120,000 over the two years, I would suggest not deferring and directing the entire distribution to the charity. Because the effect of the QCD is to zero out AGI, you would not suffer from accelerating the timing of the distribution.

Q: I have an IRA that I would like to use to fund some short-term cash needs. The problem is I am 57 and would pay a 10 percent penalty on the distribution. I am reading about substantially equal periodic payments (SEPP) as a means of avoiding the penalty. My question is if I can take these payments for three years and then stop, without penalty, because I will then be over age 59½.

If you do, you’ll pay the penalty, plus interest, on the distributions taken before age 59½. A SEPP must be paid at least annually over your life expectancy. Modifications to the payment schedule mean the payments are not “substantially equal.” You then pay the penalty.

The penalty for modifications to an otherwise qualifying SEPP plan applies unless modifications are made only after five years have passed from the first payment and after you have attained age 59½.

So a modification after age 59½ avoids the penalty only if five years have also elapsed from the first payment. If you modify at 59½, you’ll owe the penalty for the payments received before that date. If you wait five full years, you can modify without penalty.

James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.