Reducing AGI by $80K: Charitable IRA Rollover Strategy

Reducing AGI by $80K: Charitable IRA Rollover Strategy

Executive Summary

Many retirees face the challenge of Required Minimum Distributions (RMDs) from their IRAs, leading to increased tax burdens. A retired couple sought a strategy to minimize their tax liability while also supporting their charitable passions. We implemented a Qualified Charitable Distribution (QCD) strategy, directing $80,000 annually from their IRAs to qualified charities, thereby reducing their Adjusted Gross Income (AGI) by the same amount and resulting in substantial tax savings.

The Challenge

John and Mary, a retired couple in their late 70s, approached Golden Door Asset with a growing concern about their increasing tax burden. They had diligently saved for retirement, primarily in traditional IRAs. As they began taking Required Minimum Distributions (RMDs), they found a significant portion of their income being taxed. Their annual gross income, including Social Security and investment returns (excluding RMDs), was approximately $120,000. The RMDs from their combined IRAs totaled $80,000 annually, pushing their Adjusted Gross Income (AGI) to $200,000 and placing them in a higher tax bracket.

They were already charitably inclined, donating approximately $15,000 annually to various qualified charities. However, these donations were being deducted as itemized deductions, subject to the AGI limitations and the standard deduction threshold, which reduced the overall tax benefit they received. Furthermore, they expressed a desire to increase their charitable giving but were hesitant due to the impact on their tax liability.

Their specific concerns included:

• High Effective Tax Rate: The RMDs significantly increased their taxable income, pushing them into a higher tax bracket and reducing their overall disposable income. Their effective federal income tax rate was approximately 15%, costing them around $30,000 annually in taxes.
• Limited Tax Benefit from Charitable Donations: Due to the standard deduction being relatively high ($27,700 for married filing jointly in 2023) and the AGI limitations on itemized deductions, the tax benefit from their current charitable giving was minimal. They were only able to deduct a small portion of their charitable donations after exceeding the standard deduction threshold.
• Desire to Increase Charitable Giving: They wanted to contribute more to their favorite charities, but the additional tax burden associated with increased income made them hesitant.
• Complexity of Tax Planning: They found the tax landscape increasingly complex, particularly with RMDs and charitable deductions, and needed a more strategic approach to minimize their tax liability and maximize their philanthropic impact.
• Capital Gains Taxation: While not directly related to RMDs, they were also facing capital gains taxes on investments held outside their IRA, further compounding their tax burden. They were realizing approximately $20,000 in long-term capital gains annually, taxed at a rate of 15%.

The Approach

To address John and Mary's challenges, we recommended implementing a Qualified Charitable Distribution (QCD) strategy. A QCD allows individuals aged 70 ½ or older to donate up to $100,000 per year (indexed for inflation, $100,000 in 2023) directly from their IRA to qualified charities. These distributions are excluded from their Adjusted Gross Income (AGI), providing a direct reduction in taxable income.

Our strategic thinking involved the following steps:

1. Assessment of Financial Situation: We conducted a thorough review of their financial situation, including their income, assets, tax returns, and charitable giving history. This allowed us to quantify the potential benefits of a QCD strategy.
2. Education and Counseling: We explained the benefits and limitations of QCDs, ensuring they understood the rules and regulations. This included discussing the requirements for qualified charities and the implications for itemized deductions.
3. Charity Selection and Planning: We worked with John and Mary to identify their favorite qualified charities and determine the appropriate allocation of their charitable giving.
4. Coordination with IRA Custodians: We facilitated the transfer of funds directly from their IRA custodians to the designated charities. This involved completing the necessary paperwork and ensuring compliance with all regulatory requirements.
5. Tax Planning and Reporting: We provided them with detailed documentation for tax filing purposes, including a summary of their QCDs and the corresponding tax savings.
6. Ongoing Monitoring and Adjustments: We continuously monitor their financial situation and adjust the QCD strategy as needed to optimize their tax benefits and philanthropic goals.
7. Comprehensive Financial Planning: We incorporated the QCD strategy into their overall financial plan, considering its impact on their retirement income, investment strategy, and estate planning.

Our decision framework was based on the following principles:

• Tax Efficiency: Prioritizing strategies that minimize their tax burden while maximizing their charitable impact.
• Simplicity: Implementing a strategy that is easy to understand and manage.
• Compliance: Ensuring compliance with all applicable tax laws and regulations.
• Transparency: Providing clear and accurate information about the QCD strategy and its benefits.
• Client-Centricity: Tailoring the strategy to their specific needs and goals.

We specifically advised them that:

• The QCDs would count towards their RMD for the year, satisfying this requirement without increasing their AGI.
• They could not deduct the QCD as a charitable contribution on Schedule A, but the exclusion from income was a far more beneficial outcome.
• They should coordinate with their IRA custodians to ensure the checks were made payable directly to the qualified charities, not to themselves.

Technical Implementation

The technical implementation of the QCD strategy involved several key steps:

1. Identifying Qualified Charities: We verified that all designated charities were qualified 501(c)(3) organizations, as required by the IRS. We used the IRS Tax Exempt Organization Search tool to confirm their status.
2. Coordination with IRA Custodians: We contacted John and Mary's IRA custodians (Schwab and Fidelity) to initiate the QCD transfers. Each custodian has its own specific forms and procedures for QCDs.
3. Completing QCD Transfer Forms: We assisted John and Mary in completing the necessary transfer forms, ensuring that all information was accurate and complete. The forms required details such as the IRA account number, the charity's name and address, and the amount of the transfer.
4. Direct Transfer to Charities: We ensured that the IRA custodians directly transferred the funds to the designated charities. The checks were made payable to the charities, and the custodians mailed the checks directly to the charities on John and Mary's behalf.
5. Documentation and Record Keeping: We maintained detailed records of all QCD transfers, including the dates, amounts, and names of the charities. This documentation was essential for tax filing purposes.
6. Tax Reporting: We provided John and Mary with a summary of their QCDs for tax reporting purposes. We also worked with their tax preparer to ensure that the QCDs were properly reported on their tax return (Form 1040). Specifically, the $80,000 would not be included as income on line 4a (IRA distributions) of Form 1040.
7. Using Financial Planning Software: We used our proprietary financial planning software integrated with tax planning modules, which allowed us to model the impact of the QCD strategy on their overall tax liability and retirement income. The software automatically calculated the tax savings from the reduced AGI and generated reports for John and Mary to review.

The specific financial terms and methodologies used included:

• Adjusted Gross Income (AGI): The QCD strategy directly reduced their AGI by $80,000.
• Tax Bracket: By reducing their AGI, we lowered their tax bracket, resulting in a lower marginal tax rate.
• Effective Tax Rate: The QCD strategy significantly reduced their effective tax rate, increasing their disposable income.
• Standard Deduction: While they no longer itemized deductions due to the QCDs, the standard deduction still provided a baseline level of tax relief.
• Required Minimum Distributions (RMDs): The QCDs satisfied their RMD requirements without increasing their taxable income.
• Charitable Contributions: While they could not deduct the QCDs as charitable contributions, the exclusion from income provided a far greater tax benefit.

Results & ROI

The implementation of the QCD strategy yielded significant results for John and Mary:

• Reduced AGI by $80,000: Their Adjusted Gross Income (AGI) decreased from $200,000 to $120,000 annually.
• Lower Effective Tax Rate: Their effective federal income tax rate decreased from approximately 15% to approximately 9%, a reduction of 6 percentage points.
• Tax Savings of Approximately $12,000 Annually: Their annual federal income tax liability decreased by approximately $12,000, based on their new AGI and tax bracket.
• Increased Disposable Income: The tax savings increased their disposable income, allowing them to maintain their current lifestyle and increase their charitable giving.
• Fulfillment of Philanthropic Goals: They were able to increase their charitable giving without increasing their tax burden, allowing them to support their favorite causes more generously.
• Simplified Tax Planning: The QCD strategy simplified their tax planning and reduced the complexity of managing their retirement income.

Here's a breakdown of the key metrics:

The ROI of the QCD strategy was substantial, providing significant tax savings and allowing John and Mary to achieve their philanthropic goals. They were extremely satisfied with the results and appreciated the proactive approach to tax planning.

Key Takeaways

Here are some key takeaways for other advisors:

1. Identify Clients with RMDs and Charitable Intentions: Proactively identify clients who are subject to RMDs and have a desire to support charities. These clients are ideal candidates for QCD strategies.
2. Educate Clients About QCDs: Clearly explain the benefits and limitations of QCDs, ensuring that clients understand the rules and regulations.
3. Coordinate with IRA Custodians: Establish strong relationships with IRA custodians to facilitate QCD transfers and ensure compliance with all regulatory requirements. Understand the QCD process with each custodian your clients use, as processes and forms differ.
4. Incorporate QCDs into Financial Plans: Integrate QCD strategies into clients' overall financial plans, considering their impact on retirement income, investment strategy, and estate planning.
5. Provide Ongoing Monitoring and Support: Continuously monitor clients' financial situations and adjust the QCD strategy as needed to optimize their tax benefits and philanthropic goals.

About Golden Door Asset

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