Is the SECURE 2.0 Exception to allow a QCD to fund a Charitable Gift Annuity useful?
Is it a good idea to fund a Charitable Gift Annuity from an IRA?
The SECURE Act 2.0 Offers a One-time exception that allows taxpayers to fund a charitable gift annuity (CGA) or Charitable Remainder Trust (CRT) through a Qualified Charitable Distribution (QCD) from an Individual Retirement Account (IRA). While there are some differences between a CGA and CRT, for purposes of this discussion they work the same and we will refer to a CGA for simplicity.
First, there are some important rules to understand. This exception is only once in a lifetime, or rather for one year in a lifetime. The CGA can be funded by multiple gifts, but they must be within the same year, and are limited to $50,000 per person. A husband and wife can contribute to the same CGA, but no one else can contribute to it. Nor can they mingle non-QCD gifts into the CGA. The CGA must pay out at least 5% annually and must start within one year. Unlike most IRA distributions, QCDs are not taxable, including when used to fund a CGA under the new once-in-a-lifetime exception. Payments from the CGA are fully taxable as ordinary income.[1]
Funding a CGA through a QCD will count toward the current year Required Minimum Distribution, as any QCD does. For most people, the $50,000 limit per person will be well in excess of their current RMD, and it will generate lifetime income that is fully taxable. In this respect, simply making charitable contributions through QCDs will have a greater tax impact.
Funding a CGA with well in excess of the current year RMD will reduce balance of the IRA, decreasing future RMDs. This will be offset by the annual CGA payments. Assuming a 5% payout on the CGA and a 5% return on the IRA (we’re not privileging either option), using a CGA will increase taxable income for people under age 80, because their RMD is less than 5%. As a person ages, the CGA amount stays the same, but the RMD as a percentage of the IRA balance increases. Taxpayers over 80 can decrease their minimum taxable income going forward, as the CGA can be set up to pay only 5%.
The most obvious use case for utilizing the QCD to fund CGA exception is for a couple that is temporarily in a high tax bracket and has a large RMD. Take this hypothetical example: Steve and Susan are married, filing joint, and are both 85 years old. They live in California. They have $1,600,000 in traditional IRAs between them. Their RMD for 2023 is $100,000, evenly split between them. Taxable Social Security is $40,000. They have been wise about asset allocation, so their interest-bearing investments are in their IRAs, and their taxable accounts generate qualified dividends and long-term capital gains that average about $40,000 per year. This year, they had some extra sales of investments they’d held for a long time, such that they realized $120,000 in income taxed at long-term capital gains rates. They also sold their home, which generated a long-term capital gain after the exemption of $200,000. Without a QCD, they would be in the 22% marginal Federal income tax bracket, 9.3% California bracket and 15% capital gains bracket, plus be subject to the Net Investment Tax of 3.8% on most of the capital gains. They would also be subject to higher Medicare premiums in two years, adding another roughly $8,000 in premiums. Using the one-time exemption to contribute their RMD of $50,000 each into a CGA, eliminates the Net Investment Tax, and extra Medicare premium, drops the Federal marginal tax rate to 10% Federal and allows utilization of the 0% long-term capital gains tax rate on almost $80,000 of gains. Combined, this reduces taxes this year plus extra Medicare premiums based on this year by about $51,000. The $5,000 annuity payments will be taxed as ordinary income. In an average year, this would be at marginal rates of 22% Federal and 9.3% State – the same as it would have been this year. Steve and Susan will not be subject to increased Medicare premiums or Net Investment taxes unless they have exceptional gains.
Conclusion: For taxpayers with high RMDs and other earnings much higher than normal, using the one-time exemption to fund a CGA or CRT could present significant savings opportunities. For everyone else, a standard QCD or funding a CGA or CRT through taxable funds may prove a better option.
Bibliography
National Council of Nonprofits. (2023, January 18). Secure Act 2.0 Provisions of Interest to Nonprofits. Retrieved from Council of Nonprofits: https://www.councilofnonprofits.org/articles/secure-act-20-provisions-interest-nonprofits
[1] (National Council of Nonprofits, 2023)