With the first year of the Tax Cuts & Jobs Act of 2017 (TCJA) officially behind us, a lot of retirees could be heading for a rude awakening come tax time. Why? Remember the old saying about how no good deed goes unpunished? Retirees who are charitably inclined could soon learn their gifting program might actually be costing them money come tax time.
Here are the high points discussed in detail below:
The new standard deduction for a married filing jointly couple is $24,000, up from $12,700.
Many charitably inclined retirees will no longer be able to deduct charitable donations on their taxes because of the higher standard deduction.
Using qualified charitable distributions (QCD) from IRA accounts when the retiree is in required minimum distribution (RMD) phase could save the retiree tax dollars and still benefit the charity of their choice.
Arbor Wealth Management has been implementing this strategy for appropriate clients throughout 2018 and is available to discuss your portfolio and financial planning needs if you would like to learn more about this or other tax saving strategies.
Take for example our hypothetical clients, Bob and Joan Smith. Bob and Joan (73 and 71 respectively) are both retired. Bob retired from the Air Force and retired again as an engineer while Joan was a homemaker. Bob has an IRA account valued at $1,200,000.
Bob and Joan are debt free. Bob has a military pension and they both receive social security, so they collect roughly $130,000 per year in retirement. The Smiths like to give 10% of their income to their church each year, roughly $13,000 per year. And this charitable giving, combined with other Schedule A expenses, has allowed them to itemize on their tax return the last few years. Conservative investors, Bob and Joan have two portfolio goals – support their church and keep their taxable income as low as possible.
One of the major outcomes of the TCJA is a higher standard deduction for a married filing jointly couple, up to $24,000 from $12,700 in 2017. In the past few years the Smiths have itemized, using Schedule A to deduct more than the standard deduction of $12,700.
It’s unlikely, however, that they will come close to exceeding $24,000 (the new standard deduction) in medical expenses and state/local taxes along with their 10% charitable donation. So, what should they do? The answer is a qualified charitable distribution from Bob’s IRA.
Remember that Bob is 73 and that he owns an IRA. That means each year he must take a required minimum distribution from his IRA and pay ordinary income tax on that distribution. For our hypothetical let’s say that Bob has a required minimum distribution (RMD) of $48,000. That means, unless Bob chooses another strategy, he’ll add $48,000 to his taxable income for 2018.
Instead of taking those dollars as income, Bob should make a qualified charitable distribution (QCD) to his church. Assuming Bob and Joan still want to give 10% of their pension and social security income to their church, instead of paying income tax on $48,000, now Bob and Joan only owe tax on $35,000. The church receives the distribution tax free, Bob and Joan have a lower tax liability and their monthly cash flow benefits as well.
Now, if you’re thinking of implementing a QCD strategy like Bob, bear in mind there are a few catches. First, any QCD check must be made payable directly to the charity, the assets cannot flow from the IRA to you then to the charity. Second, the QCD must leave your IRA before 12/31 to count for this year, so writing a check from your IRA on 12/31 that doesn’t get deposited until 01/02 won’t count as a QCD. Third, you’re not allowed to receive a benefit in return for your donation, so no QCD checks to your alma mater for choice seats in the stadium next fall. Finally, you can distribute more than your annual RMD as a QCD, but it won’t be counted towards the next year’s RMD nor will it be a deductible donation.
There are a few more specific rules regarding QCDs, but those are the main ones to consider. If your financial advisor knows you are charitably inclined and are in RMD phase but hasn’t discussed the pros and cons of a QCD strategy with you, maybe it’s time for a second opinion.
*Disclaimer* - This blog post is purely hypothetical and is not descriptive of any person or client of Arbor Wealth Management. Although Andrew K. McDowell, Esq., CFP®, CDFA® is a Florida-licensed attorney and Certified Financial Planner™, this should not be considered individual investment advice, tax advice or legal advice, nor is it an invitation to buy or sell securities.