Retirees, Save on Taxes With This RMD-to-Charity Alternative

It's always something. Now that Congress has finally made permanent the right to transfer IRA money tax-free to charity, it turns out that this highly touted opportunity might not be the most powerful elixir of tax strategy and philanthropy. You could come out ahead by taking a fully taxable payout from your retirement account and offsetting it with a deduction for contributing appreciated assets to the charity of your choice.

Figuring out which will produce the best payoff can be complicated, but also quite valuable.

The tax-free IRA-to-charity transfer has real appeal to retirees who plan to make charitable donations and don’t need the money they must take as required minimum distributions (RMDs) from their IRAs. Sure, they could take a taxable payout, donate the cash and claim a charitable-contribution deduction. But keeping the money off the tax return in the first place has its advantages.

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First, it breathes tax-saving life into the donation for the 70% of taxpayers who don’t itemize deductions. Keeping the IRA payout off the return also insures that the amount can’t increase the portion of Social Security benefits that is taxable, lead to higher Medicare premiums or squeeze deductions that are affected by rising adjusted gross income (AGI). Medical expenses, for example, are deductible in 2016 only to the extent they exceed 7.5% of AGI for taxpayers age 65 and older. Adding to AGI can tighten that vise.

A direct tax-free transfer also means the payout can’t trigger or exacerbate the 3.8% surtax on investment income (which applies when AGI is over $200,000 on single returns or $250,000 on joint returns) or the so-called Pease limitation that squeezes the value of certain itemized deductions. The Pease bite starts when AGI exceeds $259,400 for single filers and $311,300 for married couples filing jointly. So, what’s not to like?

An Even Better Deal

As tax-savvy as a direct donation can be, taking the IRA payout as taxable income and offsetting it with a write-off for the donation of appreciated assets can be better.

If you have owned the assets such as stock or mutual fund shares for more than a year, you can deduct the full market value on the day of the charitable contribution. If you bought stock for $10,000 and give it away years later when it’s worth $30,000, you earn a $30,000 deduction and avoid tax on the $20,000 profit.

In this example, you come out more than $5,000 ahead. And, if you really want to hold on to your stock, you could use the $30,000 in cash from your IRA to buy it back. You’d only owe tax on future appreciation.

Tax-free direct transfers from IRAs to charities can work well in many circumstances. But if you have substantially appreciated assets in a taxable account, be sure to consider whether an alternative approach will serve you better. The more you save on taxes, the more generous you can be in the future.