Close Close

Financial Planning > Charitable Giving > Charitable Giving Deductions

The Charitable IRA Rollover Opportunity

Your article was successfully shared with the contacts you provided.

As we know, life insurance is an important tool in charitable giving. The “multiplier” created by the difference between the premium and the death benefit allows a charitable donor to give more than the premiums paid. That effect will give the organization more capital. For the donor, there is greater satisfaction and far greater recognition.

A provision in the Pension Protection Act of 2006 added ?408(d)(8) to the Internal Revenue Code, which will make it much easier for IRA owners to make substantial charitable gifts with single premium life insurance policies. During 2006 and 2007, the provision allows donors age 70 1/2 and older to make direct rollovers to a qualified charity of up to $100,000 without affecting the donor’s taxable income.

The provision is temporary; there is no indication that it will be renewed for 2008 and beyond. Therefore, IRA owners now have one year remaining to take advantage of this planning opportunity. Let’s look at the benefits of this provision.

Tax benefits of charitable IRA rollovers

Percentage of Adjusted Gross Income (AGI) Limitation–This is the primary benefit of this new planning opportunity. Under the old rules, if a donor took $100,000 out of an IRA and gave the funds to a charity, the amount first had to be included in gross (i.e., taxable) income. Then the donor got a charitable contribution itemized deduction. The likely problem was that the donor’s contribution deduction would run into the 50% of AGI limitation. That meant the donor would likely not be able to deduct the full $100,000 in the year of contribution.

That would force the donor to pay income tax on the difference between the $100,000 and the deductible amount. Carryover provisions allow the excess contributions to be carried forward for 5 years. Still, the donor would have to prepay some income tax (possibly a lot) and take his or her chances with being able to deduct the excess in future years.

This new provision under the act avoids the donor’s taxable income. The $100,000 is reported as part of gross distributions, but it is not included in the taxable portion. Of course, there’s no charitable contribution deduction, but you can prepay tax and take your chances with carrying over the excess contributions to a future year.

The transaction circumvents the tax return. There is no inclusion in gross income, no charitable contribution deduction and no effect on taxable income. In effect, the taxpayer can deduct the entire $100,000 charitable rollover in the year of the rollover.

Itemized Deduction Phase-Out–At higher AGIs, ?68 IRC phases out itemized deductions. Because the charitable rollover isn’t included in AGI, the new provision reduces the chance the IRA distribution would trigger phase out.

Standard Deduction–Individuals take the standard deduction because their itemized deductions aren’t large enough. Therefore, the standard deduction is more beneficial to them than itemizing. Because the charitable rollover avoids the donor’s tax return, the donor gets both the standard deduction and the charitable contribution deduction.

Effect of AGI–The medical expense itemized deduction has a 7.5% floor, and most miscellaneous itemized deductions have a 2% floor. That is, only the amounts in excess of those percentage floors are deductible. By not being included in AGI, the charitable rollover is prevented from decreasing the amounts of those deductions.

Taxability of Social Security–An increase in an individual’s “provisional income” (?86 IRC, sort of a modified AGI) may make more of the individual’s Social Security benefit subject to income tax. By not being included in AGI, the charitable rollover will not be included in provisional income, avoiding the possibility the charitable rollover would increase the amount of Social Security subject to income tax.

State income taxes–Some states do not allow deductions for charitable contributions. Therefore, the charitable rollover provisions avoid a possible increase in the donor’s state income tax.

Minimum Required Distribution (MRD)–The charitable rollover is included in determining whether or not the MRD has been made. Therefore, if the MRD was $60,000, a $100,000 distribution would satisfy the requirement and the taxpayer wouldn’t have to take any more from the IRA in 2007. Unfortunately, the excess $40,000 cannot be carried over to 2008 to help satisfy 2008′s MRD.

Spouses–The provision applies to each individual’s IRAs. In a marriage, both spouses may have IRAs. If so, each can roll over $100,000 for a combined $200,000 rollover contribution to a single qualified charity.

Conclusion–All of the above are potential tax benefits made possible by the charitable IRA rollover.

Life Insurance Considerations

One of the problems with charitable giving using life insurance is the periodic premium–it has to be paid. The donor has to write a check every year, maybe every month. Either the donor pays the premium directly to the insurance company or the donor gives it to the charity and counts on the charity to pay the premium.

The one-year nature of this provision, and its allowable maximum of $100,000, works to avoid the periodic payment problem. With a $100,000 contribution, a substantial policy can be purchased as a single premium contract.

Because the policy will be owned by a tax exempt organization, the fact that it’s a single premium contract–and therefore a MEC–is of no consequence. And because the policy is single premium contract, there are no periodic premiums; the first premium is the last one. The one year nature of the provision also makes it natural to think of this as a single premium policy.

The details

A client can distribute less than $100,000 as a charitable IRA rollover, although the smaller the distribution and the charitable rollover, the less likely it is that life insurance can be used for the transaction.

The distribution must be made from an otherwise taxable standard IRA or Roth IRA. Charitable rollover distributions are deemed to come first from the taxable portion of an IRA distribution. If a client owns an IRA with nontaxable nondeductible contributions, the charitable rollover distribution will come first from the taxable amount (deductible contributions and earnings).

Here’s an example: A client owns an IRA worth $100,000, of which $45,000 is deductible contributions and earnings. The other $55,000 consists of nondeductible contributions. If the client were to make a charitable IRA rollover distribution of the full value in the IRA, only the $45,000 of deductible contributions and earnings will qualify under the act. An itemized income tax charitable deduction must be claimed for the $55,000 of nondeductible contributions.

Deleted sentence is redundant, it repeats the first sentence of the prior bullet pointThe charitable rollover is not permitted from qualified plans, 403b annuities, Keoghs, SEPs and SIMPLEs.

The charitable rollover distribution must be gifted directly to a qualified charity. Therefore, the IRA owner must work with the IRA custodian or product provider to ensure the direct gift can be accommodated. If a client takes a distribution from his or her IRA and then chooses to make a gift to a charity, the requirements of the charitable IRA rollover will not be met and the distribution will be income taxable. The client must then claim an itemized income tax charitable deduction.

The selected charity must be a qualified charity as defined within ?170(b)(1)(A) of the Internal Revenue Code. The following entities are not considered a qualified charity: a charitable remainder trust (CRT), charitable gift annuity (CGA), pooled income fund, private foundation (other than conduit private foundations that redistribute the amount to a public charity within a designed time period) and donor advised funds.

Lastly, the qualified charity must provide written acknowledgment of the gift as described within Treasury Regulations ?1.170A-13(f). This may cause record-keeping challenges since the gift must come directly from the IRA custodian. Therefore, the client should inform the charity that the gift is coming and work directly with the charity to obtain a written receipt.

The charitable IRA rollover represents a wonderful opportunity for clients to benefit churches, Scout troops, schools, colleges, universities, hospitals, and so on. The process is relatively straightforward and should be easy to implement.

And life insurance can provide an excellent opportunity for clients to multiply and magnify their generosity. Unfortunately, you and your clients only have one year to take advantage of it, so start today.