Why the IRA Charitable Rollover is a Big Deal

It’s not often that good news comes out of Congress these days. But the nonprofit sector should give Congress credit for a provision in the federal budget that was passed in December.

First, a disclaimer: I am not making any judgment on the overall $1.1 trillion budget package. Without a doubt, there’s plenty in there to set my blood boiling. But for the purposes of this article, I simply want to address Congress’s decision to authorize what is known as “the permanent IRA charitable rollover provision.”

And here’s a second disclaimer: I’m not an attorney or a CPA, and I urge donors and charitable organizations to consult with their financial advisors to see what works best for them.

Anyway, in the last several weeks I’ve seen dozens of ecstatic notices from philanthropic associations and nonprofits praising this Congressional action, but most of the excited email blasts and blog posts don’t explain why exactly this particular action matters.

As background, it’s critical to understand that in recent decades the United States has evolved its retirement system from one wherein most workers could count on some kind of a guaranteed pension from their employers to one where workers are expected to put aside money on their own for retirement. Those savings (sometimes matched by employers) produce the core of our retirement income (supplemented by Social Security). Some prominent critics, such as Helaine Olen and Teresa Ghilarducci, describe this shift into a do-it-yourself retirement system as a public policy disaster and a Wall Street boondoggle, and I tend to agree with them. But it’s the retirement system we have – for now, anyway – and we have to make the most of it.

For this system to work at all, it’s vital that workers actually invest money for their retirement. To incentivize them to do just that, the federal government defers the income taxes on those earnings. So if Mary earns $100,000, but has $6,000 of that income put into her company’s 401(k) retirement plan or an Individual Retirement Account (IRA), she only has to pay current federal income taxes on $94,000 ($100,000 minus $6,000). She saves on taxes today by saving for her retirement.

The income tax, though, is not eliminated completely – it’s simply deferred. When Mary retires and withdraws those funds, she will have to pay income taxes each year on the amount that she takes out. And those withdrawals cannot be put off indefinitely. Even if Mary doesn’t need the money, she’s required to start withdrawing funds beginning the April after she turns 70½ – and to pay income taxes on those withdrawals.

So that brings us to IRAs and charitable giving. What if Mary were to send some of the money from her IRA directly to charity (this is what they mean by “IRA charitable rollover”) without first taking it as income? Could she avoid paying income taxes on that amount? In fact, yes: since 2006 she has been able to do just that, up to $100,000 a year. Unfortunately, Congress had been giving its permission to make this charitable transfer on a year-by-year basis. Most annoyingly for planning purposes, often Congress didn’t give its okay until the year in question was almost over. But now, in this most recent budget, Congress has authorized that donors can make a direct donation of IRA assets to charity for 2015, 2016, and every year thereafter. The IRA charitable rollover is now permanent.

This raises the question: Why is this such a big deal? After all, if donors were not allowed to give directly to charity from their IRA accounts, couldn’t they accomplish the same thing by taking the money as income and then giving it away? That is, if Juan took $10,000 in income from his IRA and then made a $10,000 charitably deductible gift to his favorite nonprofit, it would be a wash, right? After all, he’d have $10,000 of income and a corresponding $10,000 deduction for a charitable gift.

Well, not really, or at least it would not work that way for everyone. Because we have to remember, first of all, that two-thirds of taxpayers don’t itemize their taxes, and if you don’t itemize, you can’t claim a charitable deduction. (I wrote about this last July.) You might assume that people who are in a position to donate to charity from their IRAs would have complex tax situations and would almost certainly itemize, but that’s not always the case. They may not be homeowners, and homeownership is generally the largest source of deductions. Or they may be homeowners who have paid off their mortgages, so they don’t have that major expense to deduct. If a donor is not an itemizer, and if she withdraws $10,000 from her IRA and then gives it to charity, it really costs her more than $10,000 to make the gift, because she would have to pay taxes on the income, and she would get no corresponding deduction for her charitable gift.

And there’s another scenario where, even if the donor itemizes, taking the income from an IRA account and then donating it to charity is a money-losing proposition. That’s because there are limitations to what a donor can claim as a charitable deduction: 50% of adjusted gross income for gifts of cash, and 30% of adjusted gross income on gifts of securities. For some older people who are have significant assets and are very generous, but who have structured their finances so that they have relatively low taxable incomes, they may not be able to claim all of their charitable gifts on their tax returns.

So the ability to give to charity directly from an IRA account can be a big advantage to many donors, and Congress did the right thing in making this strategy permanent.

And, I have to add, Congress got another thing right by not altering the definition of what kinds of organizations qualify for these gifts.

You see, during the last few years of allowing direct gifts from IRAs to charity, Congress has prohibited giving to donor-advised funds and private foundations. The attitude of policy-makers – one that I share – is that giving to a fund that will hold your money until some future date does not benefit the country in the same way that a direct gift to an operating charity does. In the run up to this budget, along with the successful lobbying to make the IRA charitable rollover permanent, many of the big philanthropic organizations asked Congress to waive this restriction and allow gifts from retirement accounts to go to donor-advised funds.

Congress said no, and it was right to do so.

So nonprofits: Tell your donors what this is all about. It’s an important, tax-savvy, and now permanent way to contribute to charity. Donors: Talk with your advisors and see if an IRA charitable rollover works for you. And Congressmen and Congresswomen: I have to admit, in this one area, anyway, you’ve done well!

Copyright Alan Cantor 2016. All rights reserved.

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