How to Avoid Taxes on IRA Withdrawals
Retirees typically need to pay income tax on withdrawals from traditional retirement accounts. And once you turn age 70 ½, annual IRA withdrawals become required. There's a stiff 50 percent tax penalty if you miss a distribution. However, if you are in the fortunate position of not needing your IRA distributions to pay for living expenses, you can avoid income tax on the withdrawal if you donate it to charity.
Retirees ages 70 ½ or older who directly transfer their IRA withdrawals of up to $100,000 to a qualified charity will not owe income tax on the distribution. A charitable distribution from your IRA can be used to satisfy your minimum distribution requirement. "A payment to a charity counts for your required minimum distribution," says Daniel Moisand, a certified financial planner for Moisand Fitzgerald Tamayo in Orlando, Florida.
A nontaxable charitable distribution must be made directly from the trustee of the IRA to a charitable organization. If you withdraw the money yourself and then donate it to charity you will need to pay income tax on the distribution. Contributions from workplace retirement accounts including 401(k)s and 403(b)s are not eligible for this tax break, but you could roll the money over to an IRA and then make a contribution directly to a charity. You must also be at least age 70 ½ at the time the distribution is made.
Check the eligibility of the charity before initiating a charitable IRA distribution. Not all charitable contributions will qualify you for the tax break. For example, donor-advised funds are not eligible recipients. Also, take care to collect an acknowledgment of your contribution from the charity for your records.
The maximum possible nontaxable charitable contribution from your IRA is $100,000. Any amount contributed in excess of $100,000 in a single year will be counted as income and taxable. If you are married and file a joint tax return, you and your spouse can each contribute up to $100,000 to charity from your respective IRAs that will not be taxable. If you donate $10,000 from your IRA directly to a charity and you are in the 25 percent tax bracket, you will avoid $2,500 in taxes. But even a smaller $500 contribution would reduce your tax bill by $125. "If you need to take a required minimum distribution and you don't need the cash, it's a great way to get around the tax," says Trent Porter, a certified financial planner for Priority Financial Partners in Denver, Colorado.
You cannot additionally claim a charitable contribution tax deduction on a charitable distribution from your IRA. "The charity gets it pre-tax, and you don't get the deduction for donating it to charity," says Austin Chinn, a certified financial planner for Fountain Strategies in San Jose, California.
IRA charitable contributions were first created by a 2006 law as a temporary measure. The provision was renewed several times before a December 2015 appropriations bill made qualified charitable distributions a permanent feature of IRAs.
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