Gifts from IRA can provide more bang for your buck

According to the Investment Company Institute, as of last September, individual retirement account assets were 11 percent of all household financial assets ($7-3 trillion), up from 6 percent of assets two decades ago. Many people are unaware of tax and other savings they may realize by making charitable gifts-whether during life or at death-from their IRA.

Recently, Congress made permanent the exclusion from income of up to $100,000 per person per year for IRA distributions by those age 70 Vi or older that are given directly to tax-exempt charities. This "qualified charitable distribution," sometimes called a "charitable rollover," results in a greater reduction on income tax than a typical charitable deduction, but there are pitfalls to be avoided.

There are also advantages from designating a tax-exempt charity as a beneficiary of your IRA, so that when you pass away, some or all of the IRA is distributed to the charity. This provides a double tax benefit: 1) an estate tax deduction and 2) unlike when your loved ones receive the IRA, the charity pays no income tax. That creates a planning opportunity that enables you to benefit your favorite charity and leave other assets to your loved ones with no income tax and potentially no estate tax due on those assets.

On Dec. 18, Congress passed-and the President signed into law-the Protecting Americans from Tax Hikes ("PATH") Act of 2015, which makes the qualified charitable distribution permanent in any tax year beginning after 2014.

A qualified charitable distribution is any otherwise taxable distribution from a traditional IRA that is made directly from the IRA to a tax-exempt charitable organization-other than a private foundation or donor advised fund-on or after the date on which the IRA owner has attained the age of 70 Vi- At that age, an IRA owner must take required minimum distributions from the IRA and pay income tax on those distributions. The dollar amount of the distribution is based on the IRA owner's life expectancy, with the expectation that the IRA will be fully distributed by death.

An IRA owner who makes a qualified charitable distribution up to $100,000 for the tax year is considered to have satisfied that much of the distribution requirement for that year, even though the charity receives the distribution. Any qualified charitable distribution in excess of $100,000 during the tax year must be reported as ordinary income.

The qualified charitable distribution might be most advantageous for those IRA owners who don't need to take distributions from their IRAs because they are living comfortably on other assets, but are nevertheless required to take distributions.

The qualified charitable distribution from an IRA has many benefits compared to other charitable gifts. Charitable contributions that are deductible on your income tax return are limited to 50 percent of adjusted gross income (AGI) each year. If you make charitable contributions at this level, the IRA qualified charitable distribution allows you to make a contribution that isn't limited by AGI.

Because the qualified charitable distribution is excluded from your gross income, it has the net effect of lowering your AGI, which is more valuable than taking a charitable deduction on your income tax return for a number of reasons that may be important to those age 70 Vi and older.

One reason is that the 3.8 percent tax on net investment income only applies to AGI above a certain threshold. Also, up to 85 percent of Social Security income becomes taxable as AGI increases. Itemized deductions are reduced or limited based on AGI, and the cost of Medicare Part B premiums, as well as prescription drug premiums, increase as that income increases.

As an IRA owner, you may also make qualified charitable distributions that exceed your distributions for the year. For example, if your distributions will be less than $100,000, you can still make $100,000 in qualified charitable distributions. This may be a consideration as a tax-efficient way to reduce the value of your estate, thereby reducing your potential estate tax exposure. Also, it's a way to avoid the payment of income tax on those assets by you or your loved ones who may receive your IRA upon your death.

To take advantage of the qualified charitable distribution, it's important for the IRA owner to ensure that the distribution is made directly from the IRA trustee to the charity. If you receive the distribution from your IRA and then turn around and make a charitable gift, you will still pay income tax on all of it. Granted, you may still receive a charitable deduction for the gift to charity, but, as noted, it likely won't result in as great a tax savings to you.

Another potential pitfall arises if you maintain more than one IRA. The maximum total amount that may be excluded from gross income for the year is $100,000 from all IRAs that you own, not $100,000 from each IRA For married individuals filing a joint return, the limit is $100,000 per individual IRA owner.

Also, if you make more than $100,000 in qualified charitable distributions from your IRA the excess amount cannot be carried over to the following year. The excess must be included in your gross income for the tax year in which the excess distribution was made, although you may receive a charitable deduction on your income tax return.

Another way to realize tax savings with charitable gifts from IRAs is to designate a qualified charity as a beneficiary to receive your IRA when you pass away. The first potential savings is on estate tax. In 2016, each person can leave $5.45 million to individuals at their death free of federal estate tax, assuming the $5.45 million exemption amount hasn't been reduced by taxable gifts during life.

That exemption amount is adjusted for inflation each year. For the vast majority of Americans, there is no exposure to federal gift and estate tax. What many don't realize, however, is that Washington state has a standalone estate tax. Currently, Washington taxes the estates of its residents on any amount that exceeds $2,079 million in 2016-that amount also is adjusted for inflation each year. The tax rates are graduated from 10 percent to 20 percent on the excess over the exemption amount.

The value of your estate for estate tax purposes includes not only your real estate, personal property, and bank and brokerage accounts, but also the face amount of your life insurance policies, interests in businesses, property in trust, and, yes, your retirement accounts, including IRAs.

Certain deductions are available to help reduce estate tax exposure. One of the most common is the marital deduction, which generally allows one spouse to leave all of his or her estate to the surviving spouse free of estate tax. Another such deduction is gifts at death to tax-exempt charities. The estate receives a dollar-for-dollar deduction on estate tax for every dollar of the estate going to the qualified charity or charities. The charitable deduction becomes more important for married couples on the second death if the surviving spouse is expected to have an estate with a value that exceeds an estate tax exemption amount.

A charitable gift can be made via a will, a living trust, or a beneficiary designation that governs the disposition of certain assets upon the person's passing. The disposition of an IRA at death, like life insurance proceeds, is governed by the beneficiary designation on file with the IRA trustee.

The double tax benefit of leaving your IRA to charity is realized when you consider the income tax implications of the gift of the IRA to charity. Traditional IRA assets, unlike most other assets, are income tax-deferred. When the money is distributed from the IRA to an individual-whether to the IRA owner during his lifetime or to that person's loved ones at death- it's subject to income tax. A qualified charity, however, pays no income tax on IRA assets it receives.

For example, assume you will be unmarried at your death and have an estate that exceeds the exemption amount by $1 million. Your estate consists of real estate, a personal brokerage account, and a $1 million IRA. You desire to leave a $1 million gift to your favorite qualified charity. You make a gift of $1 million to the charity under your will, and leave the rest of your assets, including your IRA, to your loved ones. Your estate will receive a deduction for the $1 million charitable gift, which reduces your estate tax exposure to zero. But when your loved ones receive the IRA, the distributions they receive are subject to income tax.

The individual beneficiaries of the IRA have the option of maintaining the account as an inherited IRA. The distributions will be recalculated based on each individual's life expectancy if appropriate beneficiary designations are made. This allows the beneficiary to "stretch" the distributions-and thus the income-tax liability-over time, but the distributions are still subject to income tax when they are distributed to the beneficiary.

Take the same example, but instead, you designate the charity to receive your $1 million IRA and leave the rest of your assets to your loved ones under your will. Again, your estate receives a $1 million reduction and pays no The charity also pays no charitable estate tax. income tax when it receives the IRA assets. Your loved ones receive your other assets free of estate tax and free of income tax.

Leaving the IRA to charity at death, however, loses the power of continued income tax-deferred growth for individual beneficiaries. The IRA owner will need to balance the benefits of the charitable gift against the potential increase in value that the family might enjoy over an extended distribution period if the IRA were left to them, as opposed to other assets such as securities, that may generate income over time-and thus income tax liability to the family.