Monday January 17, 2022
Article of the Month
IRAs in 2022: New RMD Tables
With the coming of 2022, new RMD tables will be implemented. The new RMD tables will bring smaller mandatory distributions for retirement account owners. The changes on average will reflect a reduction of a few basis points. Under the 2022 RMD tables, investment returns may outpace the RMD for many years, which would allow account balances to increase.
Required Minimum Distributions
In 2021, the RMD for an individual at age 72 was approximately 3.9%. In contrast, the RMD for a 72 year old is approximately 3.7% under the 2022 tables. The reduced RMD percentages will benefit account owners as the smaller mandatory withdrawals may allow the retirement accounts to maintain a higher balance for a longer period of time.
Most individuals who turned 70½ in 2019 or earlier are required to withdraw RMDs each year. In 2019, the SECURE Act changed the law, allowing the required minimum distributions for individuals turning age 70½ in 2020 or later to begin at age 72.
The CARES Act waived the requirement to take RMDs in 2020 only. This waiver was passed in response to a large dip in investment balances at the beginning of 2020 due to the COVID-19 pandemic. The goal of the waiver was to protect retirement balances and allow financial markets to recover. This temporary pause on RMDs may have substantially increased the value of some IRAs.
RMDs can generate some tax concerns for the owner of a traditional IRA. Traditional IRAs are funded with pre-tax funds and grow within the account tax free. However, the distributions from traditional IRAs are fully taxable at ordinary income rates.
Depending on the value of the IRA, these mandatory withdrawals may shift the account owner into a higher tax bracket. For individuals who have sufficient alternate income sources, this forced withdrawal may produce an undesirable tax liability, even with slightly lower RMD tables in place.
Qualified Charitable Distributions
A qualified charitable distribution (QCD) is a gift from IRA funds made directly to a charity and facilitated by the custodian of the donor’s account. A QCD is often referred to as an IRA charitable rollover. Although legislation has changed the RMD starting age, fortunately, the age for making a QCD has remained the same at age 70½. Loyal donors may choose to simplify their charitable giving by using an IRA. This may be an especially attractive option for donors who choose not to itemize tax deductions.
Each IRA owner over age 70½ may give up to $100,000 per year in QCD gifts. QCD gifts are made to public charities for the general fund or a designated purpose. They may not be made to a donor advised fund, supporting organization or private non-operating foundation. QCDs do not produce a charitable deduction for a donor. Rather, QCDs reduce a donor’s tax liability by bypassing the income tax that would otherwise be due on the retirement distribution when withdrawn. This is a special opportunity for donors falling between ages 70½ and 72, as the QCD may help mitigate future income tax liability.
Example:QCD gifts can be used to satisfy the IRA owner’s RMDs, up to the $100,000 limit on QCDs. If a donor’s RMD is less than the $100,000 limit, the QCD is not restricted to that lower RMD amount. The donor can give up to the $100,000 limit each year through QCDs.
Nancy, now retired, celebrated her 71st birthday in December. Nancy customarily gives $5,000 in cash to her favorite charity to celebrate her birthday each year. Nancy is fortunate to have a significant stream of income from her investments and does not anticipate needing RMDs from her IRA to supplement her income. She is also lucky to have two successful and independent adult children who share her passion for investing. She does not anticipate them needing cash from her estate as they are both already high income earners.
Nancy began to think about how her future RMDs would impact her financial plan. Nancy understood from her financial advisor that due to the SECURE Act, she would not be required to take required minimum distributions (RMDs) until after she turns age 72. Her financial advisor noted that structuring her annual gift as a QCD gift from her IRA could nevertheless assist with her tax planning objectives.
Nancy directed her IRA custodian to transfer $5,000 to her favorite charity as a QCD gift. This QCD gift would not be deductible for income tax purposes. However, the gift allows Nancy to give these funds tax-free and reduce her future RMDs by drawing down her account balance. Nancy is pleased to make her birthday gift out of her IRA.
IRA owners are not able to prepay RMDs for future years, but can use the QCD to offset any portion of the RMD for the current year. For donors who are subject to RMDs, QCDs remain a valuable option for reducing the taxable income generated by RMDs without needing to itemize charitable deductions.
Anton has turned age 72 and must start taking RMDs from his traditional IRA. His financial advisor estimated that his first RMD payment would be about $50,000. Anton supports local charities in his area. He reached out to his financial advisor to determine if there was any way to structure his RMD payment to reduce the likelihood he would be pushed into a higher tax bracket. He decides to use his IRA RMD amount as the value for his QCD to offset the tax implications he otherwise would have realized if he accepted the RMD as income. The QCD amount is not considered taxable income to Anton and satisfies his traditional IRA mandatory withdrawal for the year.Under the SECURE Act, the QCD annual maximum amount will be reduced by the donor’s pre-tax IRA contributions after 70½. This may impact a very small subset of charitably-inclined donors, but is very important for professional advisors to understand.
If a donor makes tax deductible contributions to an IRA after age 70½ the QCD treatment will be impacted. There will be a cumulative tracking of the post age 70½ pre-tax IRA contributions. For an IRA owner with large accumulated pre-tax contributions made after age 70½, the QCDs may be impacted for an extended period of time. The donor will have a partial recapture of the pre-tax amounts given as a QCD, which due to its taxable nature, would make that portion of the charitable gift eligible for a charitable income tax deduction.
Example:The 2022 IRA RMD tables have reduced the mandatory withdrawal percentages for account owners. The IRA charitable rollover or QCD remains a valuable planning option for donors who wish to mitigate the income tax consequences of current and future RMDs through their philanthropy. This result may be particularly compelling for those who took advantage of the CARES Act RMD waiver and now have larger account balances and larger future RMDs.
Octavia loves her career and has continued to add to her traditional IRA, even though she has reached age 73. She understands that she can make tax deductible contributions to her IRA as long as she has taxable compensation. Octavia currently receives required minimum distributions (RMD) from her IRA. Given her current income, investment income and social security distributions, Octavia does not feel as though she needs the additional income that the IRA distributions will provide. She noticed that with her RMD last year, there was an increase in her income taxes.
Her advisor explains that if Octavia wants to make an IRA charitable rollover gift to charity, the tax implications for the QCD will be impacted by the value of her pre-tax contributions to the IRA. The advisor gave a detailed response and explanation. In 2021, Octavia made pre-tax contributions to her IRA in an amount of $7,000 and made a QCD to charity of $10,000. Because Octavia made a tax deductible contribution to her IRA, the QCD will be partially-taxable due to the pre-tax IRA contributions. Her QCD will be taxable income in the amount of $7,000 due to the cumulative value of the pre-tax IRA contributions made after she turned 70½. The remaining $3,000 of the QCD will be excluded from her taxable income. Octavia would be able to claim an itemized deduction for the $7,000 of recaptured IRA contributions that do not qualify as a QCD. The remaining $3,000 will be treated as a QCD and excluded from her taxable income.