Think outside the box on RMDs, 3B
Consider taking a large withdrawal — much larger than the RMD — and combining it with a charitable remainder trust (CRT) or a donoradvised fund (DAF). Traditional route is OK, but there are other ways to cushion blow to pocketbook
Q: By the end of 2016, I will take the required minimum distribution from my IRA. Most likely this will also affect my Social Security income and make for a substantial tax burden compared to past years. At 701⁄2 this is a huge concern. Do you have any ideas as to how to cushion the blow? Donating funds and using this as a tax deduction is one, but what else is there? — Gary Urcheck, Ohio
A: We’ll start first with a few traditional tactics and then give you what one adviser calls an “outside-the-box” approach. First the traditional: Consider buying a qualifying longevity annuity contract or QLAC inside your IRA. You can use up to 25% of your IRA ( but not more than $125,000) to purchase an annuity from an insurance company. The QLAC helps reduce your RMD. The $125,000, or whatever amount is invested in the QLAC, is taken out of your “base” for computing RMDs on the rest of the IRA.
Consider, as you suggested, making a qualified charitable distribution, or QCD. A QCD, according to the IRS, is generally a non-taxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions.
You must be at least age 701⁄2 when the distribution was made. Also, the IRS says you must have the same type of acknowledgment of your contribution that you would need to claim a deduction for a charitable contribution. Of note, the IRS also says the maximum annual exclusion for QCDs is $100,000 and that any QCD in excess of the $100,000 exclusion limit is included in in- come as any other distribution.
Also, if you file a joint return, your spouse can also have a QCD and exclude up to $100,000, according to the IRS. The amount of the QCD is limited to the amount of the distribution that otherwise would be included in income. If your IRA includes non-deductible contributions, the distribution is first considered to be paid out of otherwise taxable income, the IRS says.
Ultimately, the QCD is a great way to do good and to reduce the IRA balance used to calculate your RMDs. But ... make sure the QCD/RMD is sent directly to a qualified charity of your choice by the IRA custodian.
Now for the out-of-the-box idea. Consider taking a large withdrawal — much larger than the RMD — and combining it with a charitable remainder trust (CRT) or a donor-advised fund (DAF), says Dave Spence, a certified financial planner with Palladium Wealth Management.
“This approach reduces the fu- ture RMDs, which means less future IRA taxes, potentially less inclusion of future Social Security income in your taxes and lower future premiums for Medicare to be withheld from Social Security benefits,” he says. “What one pays in Medicare premiums is based on total reported income, so the large withdrawal may cause a one-year spike in that premium, after which, the regular amount to be withheld would potentially be lowered for many years.”
Now, he says the contribution to a DAF could be looked at as prepaying — and deducting — many future years of charitable contributions all at once, in the year of the large spike in income associated with the large IRA withdrawal.
He gave this example: If one normally contributes $5,000 per year to their church, they could put $50,000 into the DAF this year and send $5,000 each of the next 10 years from the fund, but get the entire $50,000 deduction this year.
“A charitable remainder trust or CRT is more complicated but provides a current-year tax deduction based on the amount contributed and the length and amount of the annuity that the CRT would pay to the donor before the balance would ultimately pass to a qualified charity,” Spence says.
He gave this example: A taxpayer withdraws $200,000 from his IRA, puts it all into a CRT, withdraws 4%,5%, 6% — whatever amount he decides to build into the trust terms — for a fixed number of years or for the rest of his life.
“Whatever remains in the CRT at the end of the annuity period passes to the charity, but the deduction (a calculated percentage of the $200,000) is deducted in the same year the large withdrawal is reportable,” Spence says. “The taxpayer, you in this case, could structure the CRT terms to maximize either the deduction or the annuity payments to suit his goals.”