Saturday March 2, 2024
Case of the Week
Gifts from IRAs, Part 9
Case:Quentin Charles Douglas was the firstborn child in a large family. Throughout his childhood, Quentin's parents worked hard to put food on the table for their children. They also instilled in Quentin the value of hard work and saving money. Quentin took those lessons to heart, putting forth his best effort in school, finding a rewarding job and putting away as much in savings as he could. For many years, Quentin worked for a company that offered a 401(k) plan. During those years, he put as much into his 401(k) as he could afford so that he could maximize the benefit of his employer's matching contributions. Eventually, Quentin moved on to other employment and made a tax-free rollover of his 401(k) into an IRA. As he approached retirement, Quentin continued to contribute to his retirement savings by maxing out his IRA contributions each year.
With his lifelong penchant for saving money and some savvy investing, Quentin was able to retire comfortably at age 65. Now, a few years later, Quentin accepted a job doing what he loved. With this new job, he would like to continue to add to his traditional IRA even though he has reached age 72. He understands that he can make tax deductible contributions to his IRA if he has taxable compensation. Quentin has started receiving required minimum distributions (RMD) from his IRA. Given his lifetime savings, investment income and social security distributions, Quentin does not feel as though he needs the additional income that the IRA distributions will provide – especially with the increased taxes tied to that income.
Question:Quentin would like to make tax deductible contributions to his IRA while he is working. These tax deductible contributions to his IRA will lower his taxable income while he is working. Quentin wonders if he could also use an IRA qualified charitable distribution (QCD) to lower his taxable income in the same year. While the idea is still fresh in his mind, Quentin sends an email to his trusted advisor asking whether an IRA charitable rollover can be used in the same year he makes tax deductible contributions to his traditional IRA.
Solution:Quentin receives a response from his advisor explaining that tax deductible contributions to a traditional IRA after age 70½ may impact the IRA owner's QCDs. This impact may not be isolated to the year the tax deductible contribution is made because the post-age 70½ contributions to an IRA will be held cumulatively against QCDs. In 2022, Quentin is able to contribute up to $7,000 pre-tax to his traditional IRA.
His advisor explains that if Quentin wants to make an IRA charitable rollover gift, the tax implications for the QCD will be impacted by the value of his pre-tax contribution to the IRA. The advisor includes an example in his email response: In 2022, Quentin makes pre-tax contributions to his IRA in an amount of $7,000 and makes a QCD to charity of $10,000. Because Quentin made a tax deductible contribution to his IRA, the QCD tax treatment will be impacted. Quentin's QCD will be taxable in part. His QCD will be taxable income in the amount of $7,000 due to the cumulative value of the post-age 70½ IRA contributions. The remaining $3,000 of the QCD will be excluded from his taxable income. Quentin would be able to claim an itemized deduction for the $7,000 of recaptured IRA contributions, while the $3,000 will be treated as a QCD and excluded from taxable income.
Quentin is very glad he reached out to his advisor before moving forward with his plan to add to his IRA when he returns to work. He responds to his advisor by asking if there are other options available that will allow him to save and continue to use his QCD.
Editor's note: The post-age 70½ deductible IRA contributions are cumulative, so for an IRA owner with accumulated contributions, his or her IRA QCDs may be impacted for an extended period of time.