Wednesday, October 19, 2011

Should My IRA Make Charitable Contributions?

An important benefit of an individual retirement account (IRA) is that you can accumulate earnings on your savings dollars without paying taxes on them until you start withdrawing from the account.  This can go on for many years, but at age 70 1/2 you are required to start taking yearly minimum distributions from the account.  The amount of these distributions depends on your life expectancy according to tables published by the IRS.  Gradually as you get older, your yearly minimum distributions will get larger as your life expectancy shortens.

You are fully taxed on these distributions.  In addition, your IRA distributions may cause more of the social security payments you receive to be taxed.

Some kind people choose to donate their IRA distribution to their favorite charity.  They want to benefit the charity, obviously, but they also hope to offset the IRA income with a charitable contribution deduction.  

In some recent years, and again in 2011, the law allows for people to instruct their IRA administrator to make a contribution from their IRA directly to the charity rather than to take the money personally and then donate it.

The question is:  Should I have my IRA make my charitable contributions for me?

If you required to make a minimum distribution the answer is yes.  Here are some of the reasons:

1.  If you are claiming the standard deduction, you won't get to deduct the charitable contribution.  By making the contribution directly from your IRA you benefit from not paying tax on the required distribution.

2.  If you are itemizing deductions, you avoid a reduction in medical and your "miscellaneous" itemized deductions by having your IRA make a contribution.

3. Many tax deductions and credits have adjusted gross income limits.  You can qualify for more of them by having your IRA make a contribution in place of all or part of your required minimum distribution.

So how much difference will it make?  A single person with a $75,000 income is likely in the 25% federal and 5% state bracket (for a total of 30%).  If that person is required to take a $20,000 IRA distribution, they can save $6,000 in taxes.  Someone who really wants to make a difference for their favorite cause can make a $20,000 donation for a net cost of $14,000.

But what if that person is living more modestly on a $2,000 monthly fire department pension plus a $1,000 monthly social security check, is required to take a $3,000 IRA distribution and have pledged $100 per month to their favorite charity.  Can this help them?  Because the IRA distribution changes the tax on the social security, both people are in the same 30% tax bracket.  If the contribution pledge is met by a direct payment from the IRA, $360 in tax is saved compared with sending in monthly donations personally.  (30% of 12 months of $100 donations)


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