Directing IRA funds to charity is a wonderful idea because charities pay no income tax! Every IRA dollar that goes to you or another individual is immediately reduced by income tax, but a charity will take the full amount of the payout. There are rules to follow (and review with your advisors) but here is a guide to get you thinking.

Give lifetime IRA gifts to charity if you are 70½ or older

Saving in an IRA is great, but when you reach a certain age (72, or 70½ if you reached 70½ before 1/1/20), you must start taking an annual “RMD,” or Required Minimum Distribution. The amount of your yearly RMD is based on your life expectancy and the size of your IRA. You must take it, even if you do not need the money, or else pay a stiff penalty. The RMD you get is “ordinary income” and you must pay income tax on it.

Suppose you do not need or want all the income from your RMD this year

Provided you are over 70½, you can direct up to $100,000 of your RMD to charity each year via a “QCD,” or Qualified Charitable Distribution. The charity must be a 501(c)(3) charity, but it cannot be a Donor Advised Fund, Private Foundation, or a Supporting Foundation. And, you may not receive any benefit in return (like membership in the organization, a mug, a tote bag, a charitable gift annuity, or anything else).

The amount you direct to charity will reduce the size of your RMD—and reduce your taxable income. You will get no charitable deduction, but given today’s tax rules, reducing income may be more useful to you than a tax deduction.

How do you make a QCD?

Discuss your intentions with your lawyer or accountant. If it is right for you, instruct the financial institution that holds your IRA to send the donation directly to the charity of your choice. Do this well before December 31, so the financial institution will have time to process your request.

Give IRA funds upon your death by beneficiary designation

Unlike individuals, a charity pays no income tax on money from an IRA. This means that giving $10,000 of IRA to charity means the full $10,000 will go to the charity. In contrast, if you gave the same $10,000 of IRA to your nephew, he must pay income tax on it. Instead, give your nephew an asset he will take free of income tax – like life insurance, a bank account, or an investment account. Talk with your advisors and then simply update your beneficiary designation form by naming the charity (or several of them).

Name a charity as “contingent beneficiary”

You can name one or more individuals as the primary beneficiaries, and a charity (or more than one) as the “contingent beneficiary.” If the individuals predecease you or disclaim the gift (they say, “no thanks”), it goes to charity, free and clear of income tax. Any distributions to charity will also escape estate tax if you have a large estate.

Do you have a very large IRA? A Stand-by Charitable Remainder Trust can help smooth out income tax

Your lawyer can create a Stand-by Charitable Remainder Trust to receive your IRA (or a portion of it) when you die. The trust can be designed to pay income to individuals (like your children) for a term of up to twenty years, with the remainder going to charity at the end of that time, thus creating a charitable deduction for your estate and stretching out how long your beneficiaries receive payments.

Why would you do this?

Until recently (in the “good old days” before the SECURE ACT of 2020), your beneficiaries could take advantage of the “stretch IRA.” A “stretch IRA” lets the beneficiary who inherited your IRA take the funds out over her lifetime, thus spreading out the income (and the taxes) over many years. It is still possible to do this for a surviving spouse, a minor child (not a grandchild!), a beneficiary less than 10 years younger than you are, or a disabled beneficiary, but for most situations, it is “game over!” For people who died in 2020 and after, beneficiaries (other than those few exceptions) must take out the entire IRA amount before the end of 10 years and pay income tax on it. If you have a big IRA, this makes a big difference.

Suppose Mom has $1,000,000 in an IRA. When Mom dies it goes to her daughter, Sally. Sally must withdraw the entire amount within ten years and pay income tax on it. Spread out evenly over ten years, that could be $100,000 or more in taxable ordinary income each year, with income taxes knocking down the gift by perhaps $40,000 a year. Instead, if the $1,000,000 IRA goes to a Stand-by Charitable Remainder Trust, the income can be spread out over 20 years (or possibly over Sally’s lifetime), allowing the distributions to be more spread out, thus likely triggering less income tax. At the end of 20 years, the charity will get a handsome gift as well. You need professional guidance from your attorney, accountant, and the charity’s planned giving department to design and implement a trust that works for you, but it could be worth it to the charity and to your heirs.