The Most Effective Way for IRA Owners Age 70½ and Older to Give To Charity in 2006 and 2007 Using the New Tax Law

For years, charities have lobbied Congress to permit IRA owners to make charitable contributions from their IRAs. Finally something has happened. With the Pension Protection Act of 2006, Congress has provided an opportunity for individuals age 70½ and older to give up to $100,000 per year directly from their IRAs to the charity of their choice (note: donor–advised funds do not qualify). As it currently stands, however, this opportunity is only available for years 2006 and 2007. This provision has great potential to spur charitable giving by providing donors with tax benefits that “sweeten the deal. ” When executed correctly, this is a win-win situation for both the charity and the taxpayer.

For 2006 and 2007 only (unless the law is extended for subsequent years), if you fit the demographic, you should do things differently than you have in the past. Which assets you use, the timing, and the order in which you use them become critical considerations in realizing the maximum tax benefits. Because IRA contributions of up to $100,000 made directly from your IRA to your favorite charity (or charities) do not count as income, you can reduce your Adjusted Gross Income (AGI) which can have many positive tax implications.

Here is your best charitable strategy for 2006 and 2007: 

  1. Make whatever charitable contributions you are going to make anyway directly from the Minimum Required Distribution (MRD) of your IRA, but not more than the MRD. Using your MRD is a “no brainer” because the money is neither taxed nor included in your AGI. (Note: If you have taken your MRD for this year, you cannot take advantage of this opportunity.  If you have already taken a portion of your MRD for 2006, you should only make a charitable contribution directly from your IRA for the remaining amount—the charitable contribution must go directly from the IRA to the charity. )
  1. Charitable contributions in excess of the MRD should usually come from either highly appreciated stock or other money that you have already paid income tax on. That will preserve your IRA, you will not incur any taxable income, and you usually get the benefit of the charitable deduction. However, see below if you are up against the annual limits for deducting contributions.

Capitalizing on the Tax Benefits

You Can Deduct a Greater Amount of Large Charitable Gifts
by Using your IRA to Help Fund the Gifts

There are AGI limitations related to charitable gifts. Cash gifts can be deducted up to 50% of your AGI and non-cash gifts can be deducted up to 30% of an your AGI. Because of these limitations you may not always be able deduct the full amount of your charitable contribution in the initial year of the charitable gift, although you can choose to carryover your charitable deductions to future years (there is a maximum carryover period of five years). If you otherwise would not be able to deduct the full amount of your charitable gifts this year or next year because of the 50% AGI limitation for cash gifts and 30% AGI limitation for non-cash gifts, you should strongly consider funding as much of your charitable gifts as possible with your IRA. To the extent that the gift is funded with your IRA, it will have no impact on your AGI limitation because IRA contributions to charity are not counted as income and are not counted as itemized deductions subject to the limitations.

Furthermore, donating part of your IRA to charity this year and next year may enable you to deduct your charitable gifts that were carried forward from previous years that would have otherwise been nondeductible due to the AGI limitations. So, if you are age 70½ or older and are planning a large charitable gift in 2006 or 2007, you should definitely consider using your IRA to fund the gift.

Consider Supersizing Your IRA Charitable Gift
by Using it to Fund a Life Insurance Policy for Your Charity

Combining life insurance with your charitable gift is a wonderful way to maximize the leverage of your gift. A 75 year old husband and wife who can each give $100K from their IRAs during these two years could potentially (health dependant) fund a second-to-die life insurance policy owned by the charity with a $1M or greater death benefit. Maximizing your gift may give you greater control to direct the disposition of the proceeds for the benefit of your charity of choice.

If You Have After-Tax Dollars in Your IRA, Making IRA Gifts Now
Will Make Roth IRA Conversions More Attractive in the Future

If you have an IRA that includes after-tax contributions (amounts that have already been subject to income tax), please read this paragraph carefully. Because the new law states that an IRA contribution to charity will be treated as only being contributed from the taxable dollars in your IRA, you can give part of the taxable portion of your IRA to charity now so that you can pay less income tax to convert the IRA to a Roth IRA in a future year (in 2010, everyone can make Roth IRA conversions regardless of income). This could be a tremendous opportunity for you to make a Roth IRA conversion at a significantly reduced cost depending on the total size of the IRA and the size of your IRA after-tax contributions.

Reducing Your AGI through Using Your IRA to Make
Charitable Gifts Can Have Many Additional Tax Benefits for You

To the extent that you have not taken your MRD from your IRA, you can direct your MRD to charity through making a charitable gift. If you are a higher income taxpayer, directing your MRD to charity will reduce your AGI which may minimize the impact of phase-outs on miscellaneous itemized deductions, medical expense deductions and itemized deductions. In addition, the reduction in AGI may permit you to deduct rental losses, to increase your exemption deduction and may even make you eligible for a Roth IRA contribution if you have earned income. As an additional point, if you are a non-itemizer, contributing from your IRA is better than using after-tax funds in all cases since you are not eligible to deduct charitable gifts unless you itemize.

What You Should Do With This Information

We recommend that you contact a qualified advisor to discuss how you can use this new law to maximize both your charitable giving and your personal tax benefits.

James Lange is the owner and principal of James Lange Law Offices and of James Lange & Associates. He is frequently quoted in the Wall Street Journal and his new book, Retire Secure!, validates his standing as one of our country’s foremost retirement experts.

Matt Schwartz is an associate with James Lange Law Offices. He specializes in retirement & estate planning and estate administration.

Steven T.  Kohman is a CPA, CSEP and CSRP with James Lange & Associates.