King & Wood, P.A.

How to Use Qualified Charitable Distributions in Estate Planning

“A qualified charitable distribution is a direct transfer of traditional IRA funds to a qualified charity.”

Assets held in Individual Retirement Accounts (IRAs) are unquestionably the best assets to gift to charity, since IRAs are loaded with taxes. One way to relieve this tax burden is by using the IRA for charitable giving during your lifetime, says a recent article, “Giving funds in IRAs to charity with QCDs,” from Investment News.

Most people who give to charity don’t receive the taxable benefit because they don’t itemize deductions. They instead use the higher standard deduction, which offers no extra tax deduction for charitable giving.

Older taxpayers are more likely to use the standard deduction, since taxpayers aged 65 and older receive an extra standard deduction. In 2022, the standard deduction for a married couple filing jointly when each of the spouses are 65 and older is $28,700. The exceptions are couples with large medical expenses or those who make large charitable gifts.

Here’s where the IRA for charitable giving comes in. IRAs normally may not be given to charity or anyone in the owner’s life (except in the case of divorce). There is one exception: giving IRAs to charity with a QCD.

The QCD is a direct transfer of traditional IRA funds to a qualified charity. The QCD is an exclusion from income, which reduces Adjusted Gross Income. AGI is the most significant number on the tax return because it determines the availability of many tax deductions, credits and other benefits. Lowering AGI with a QCD could also work to reduce “stealth” taxes–taxes on Social Security benefits or Medicare premium surcharges.

QCDs are limited to $100,000 per person, per year (not per IRA). They can also satisfy RMDs up to the $100,000, but only if the timing is right.

There are some limitations to discuss with your estate planning attorney. For instance, QCDs are only available to IRA owners who are 70 ½ or older. They can only be made once you turn age 70 ½, not anytime in the year you turn 70 ½. The difference matters.

QCDs are not available from 401(k) or other employer plans. They also aren’t allowed for gifts to Donor Advised Funds (DAFs) and private foundations, and they can’t be made from active SEP or SIMPLE IRAs, where contributions are still being made.

Appreciated stocks can also be gifted to qualified charities and itemized deductions taken for the fair market value of the stock, if it was held for more than one year. There’s no tax on appreciation, as there would be if the stock were sold instead of gifted.

There are some tax traps to consider, including the SECURE Act, which allows traditional IRAs to be made after age 70 ½. However, it pairs the provision with a poison pill. If the IRA deduction is taken in the same year as a QCD, or any year before the QCD, the QCD tax exclusion could be reduced or lost. This can be avoided by making Roth IRA contributions instead of tax-deductible IRA contributions after age 70 ½.

Speak with your estate planning attorney about whether using a QCD makes sense for your estate planning and tax situation.

Reference: Investment News (Dec. 9, 2022) “Giving funds in IRAs to charity with QCDs”

Do You Lose Benefits If You Retire Early?

“Claiming Social Security before full retirement age (FRA) has consequences–namely, that you'll get stuck with a lower monthly benefit for life.”

Not everyone retires because they want to. A lost job, serious illness or large life change could put you into an early, unwanted, retirement. A recent article from USA Today titled “Forced to retire early? 3 things you can do to put off filing for Social Security” explores the options.

The first thing most people think of is taking Social Security benefits before Full Retirement Age (FRA), which has long-term consequences. The idea seems logical: by taking benefits, you’ll protect your retirement nest egg. However, you’ll receive a lower monthly benefit for life. Instead, consider a few alternatives.

Pursue a part-time job. If finding a full-time job doesn’t work, or if you aren’t physically or mentally able to work full time, a lower-stress part time job could fill in the financial gaps. Employers are eager to find qualified workers, in all kinds of workplaces. You might score a remote part-time job, which would be ideal if mobility is an issue. You may prefer a position where you interact with the public, like the greeter at big box stores. If you’re savvy enough to score a high paycheck, you might be able to get by on a different income level, while letting Social Security benefits grow.

Revise your spending significantly. Take a look at your cashflow. If you’re in a hot housing market, can you sell your current home and move into smaller quarters? Does your family still need two (or three) cars? If you’re among the average Americans who dine out at restaurants several times a week, a return to eating at home could help your budgeting. How many streaming services are you paying for every week?

In some instances, you can’t cut spending, especially for medical care. However, chances are there are some cuts you can make to help trim spending and reduce the withdrawals from retirement accounts, including IRAs, SEPs or 401(k)s.

Can your home create income? Monetizing your home can take a few different forms. Today’s reverse mortgages are not the same as they were thirty years ago. Depending on how much equity you have in your home, you might find the monthly checks help avoid having to take Social Security early.

Could you take in a roommate to help with monthly bills? Obviously, this step requires a lot of thought. However, if an additional $500 would tide you over, it might be a viable option—and you may enjoy the company. There are non-profit organizations that pair seniors with roommates. There are also online apps for people to rent out their fenced backyards by the hour to dog owners who need a safe place to play with their pets.

Knowing there are options can make financial stress a little less overwhelming. Do your homework and find what works for your situation.

Reference: USA Today (June 26, 2022) “Forced to retire early? 3 things you can do to put off filing for Social Security”

Can I Pay Less Taxes on My Retirement Funds?

“You don't get to use all the money in your traditional 401(k) and IRA for retirement because you still have to pay taxes on it.”

No one likes paying taxes on retirement funds. However, unless you have a Roth IRA or SEP, funded with after-tax dollars, you will owe taxes on withdrawals. However, according to a recent article from U.S. News & World Report, “How to Pay Less Tax on Retirement Account Withdrawals,” there are strategies to reduce taxes on your retirement account withdrawals.

Avoid the early withdrawal penalty. If you take money from a traditional IRA before age 59½, the penalty is 10% plus the income tax due on the withdrawal. If you are in a pinch and need the funds, you would be better off taking withdrawals from a 401(k), which is penalty free if you leave the job associated with the 401(k) at age 55 or later. You might be able to avoid the penalty if the money is needed for a large medical bill, college costs or a first home purchase.

Roll over a 401(k) without tax withholding. Changing jobs? If you take money from a 401(k) when you change jobs, 20% is held for income tax. If you do not put the entire distribution directly into a new retirement account, you could end up owing income tax and the early withdrawal penalty. One way to avoid the tax withholding and penalties is to do a direct transfer from your 401(k) to the trustee of another 401(k) or IRA. Trustee-to-trustee transfers are not generally considered a taxable event.

Manage your required minimum distributions. IRA and traditional 401(k) owners are required to take minimum distributions after age 72. Missing an RMD is expensive: the penalty is 50% of the amount you should have withdrawn, plus income taxes. However, if you are still working after age 72 and do not own 5% or more of the company you work for, you can keep delaying those RMDs from a 401(k) account held for you by your employer until you retire. For IRAs, you still have to take those withdrawals.

Be careful about distributions. Plan the distributions for the first year. You do not want to take two distributions and risk getting bumped into a higher tax bracket. The first RMD needs to be taken by April 1 of the year you turn 72 (or 70½ if you were born before July 1, 1949). The second and all subsequent distributions are taken by December 31 each year. If you delay the first distribution until April, you will end up taking two distributions, which could lead to a big tax bill.

Taking withdrawals earlier than age 72. By taking traditional retirement account withdrawals during your 60s, you can spread the tax bill over more years and enjoy the benefits of a lower tax bracket, reducing your overall lifetime tax bill. Try to take 401(k) or IRA withdrawals during a year when your income is low, like after you retire but before you take Social Security benefits.

Consider a qualified charitable distribution made directly from your IRA. Retirees 70½ or older can avoid income taxes on IRA withdrawals of up to $100,000 (or $200,000 per couple), if they make a QCD directly from their IRA to a qualifying charity. You can also donate part of your RMD and withdraw the rest of income.

Keep tax-preferred investments out of retirement accounts. If you have investments generating long-term capital gains in a retirement account, you will pay a typically higher regular income tax rate when you take the funds from the account. By contrast, you can lower the taxes by holding more highly tax investments (like Treasury inflation-protected securities, corporate and government bonds and funds generating short-term capital gains) within retirement accounts.

Balance retirement funds taxes with your overall retirement plan to try to minimize taxes. Do not neglect to discuss tax planning when you sit down with your estate planning attorney to create or revise your estate plan.

Reference: U.S. News & World Report (March 8, 2022) “How to Pay Less Tax on Retirement Account Withdrawals”

Tackling Estate Plan Quarter by Quarter

“Death, taxes and our fingers are a few things we can count on. As for the former, taxes will be owed, and death is certain.”

Most of us know that a tax bill is typically due on April 15, and we know that our paychecks will include deductions for taxes, Social Security, and IRA or 401(k) contributions. If we are self-employed or retired, we make quarterly estimated tax payments. We plan throughout the year to be better prepared when April 15 comes around. The preparation takes place routinely over time, and the same can be done for estate planning and updating, says a recent article “Make quarterly payments to estate plan” from Victoria Advocate. It’s simple and sensible.

If we can make our plans today to make our eventual passing easier for loved ones and friends, why not divide and conquer, in a quarterly manner? Consider these quarterly “payments” to your estate plan and your family:

First Quarter: Review current estate plans with your estate planning attorney. Don’t have an estate plan? Get started. An estate plan includes a Will, Durable Power of Attorney, Medical Power of Attorney, Directive to Physicians document and any trusts you might need.

The Will, aka Last Will and Testament, is the only one of these documents to be used post-mortem. The will is used to designate an executor to carry out your wishes and designate a person or persons to serve as legal guardians for minor children.

Second Quarter: Let your family know your wishes. Open communication with family members is a gift, so they are not left guessing during critical times. Finding the right words is not always easy, so try writing out your thoughts as you prepare your estate plan. Document your wishes for burial arrangements, information they’ll need for a death certificate or obituary. Do you want to donate your organs, or will your pet need special care? Where are your important papers located? Once you’ve had all the necessary documents created and have thought through these wishes and written a memo about them, let your future executor know what your wishes are, and where they can find the information that they’ll need.

Third Quarter: Do some easy but important estate planning tasks. Review the beneficiaries listed on your accounts. Assets and accounts that pass through beneficiary designations are not controlled by the will, so this is extremely important if it’s been more than a few years since you last reviewed these documents. Your IRA, SEP, 401(k), life insurance and any accounts titled Transfer or Payable on Death probably have beneficiaries listed.

Fourth Quarter: Does your estate plan include a legacy to future generations or charities? Speak with your estate planning attorney about how to pass your estate to children or grandchildren. If you have a unique goal, trusts can be as individual as you are.

As systematically as you pay taxes and bills, work through your estate plan so that you are prepared for the two things we know will occur, regardless of how we feel about them—taxes and death.

Reference: Victoria Advocate (May 8, 2021) “Make quarterly payments to estate plan”

Five Top Reasons to Add Beneficiaries to Investment Accounts

“Losing a loved one isn’t just an emotional burden—it also carries an administrative load. There are flower arrangements to pick, eulogies to write and a stream of paperwork to sort through.”

One way to show loved ones that you care, is by having an estate plan and communicating your wishes to them clearly, notes the article “Why You Should Add Beneficiaries to Your Investment Accounts Now” from The Street. That includes adding beneficiaries to your retirement and investment accounts. This simple step will help save heirs time, money and emotional stress at a time when they are likely to be overwhelmed with grief and paperwork.

They’ll retain more of your estate and get it faster too. When beneficiaries are assigned to investment and retirement accounts, the assets pass directly to them. If there are no beneficiaries, the asset may have to go through probate, the legal process of settling an estate when someone dies.

Probating an estate usually involves going to court, which is something your beneficiaries would probably prefer not to deal with during a challenging time. A typical probate case could last a year, sometimes longer, depending on where you live. During this time, your beneficiaries are not able to access their inheritance. Going to court also means court fees, attorney fees, lost time, and additional stress.

Let’s not leave out how much of a bite probate can take out of your estate. Depending on its complexity, probate can consume anywhere from 0.5% to 5% of the estate.

Removes one stress for loved ones. Having assets transfer directly to beneficiaries lessens what can be an intense burden for heirs, while they are grieving. Once the account provider is notified of the death of the account holder, the provider typically notifies beneficiaries. The beneficiaries have to provide the correct documentation, like a death certificate, but that’s a whole lot easier than going through probate. Obtaining death certificates is usually part of the executor’s responsibility and doesn’t cost very much.

Beneficiary designations override your last will and testament. By law, a beneficiary designation determines who receives assets, regardless of what is in your will. That’s why it’s so important to make sure your beneficiary designations are up to date. What happens if you neglect to update your beneficiaries on a life insurance policy purchased when your children were young? For instance, what if you are divorced from their father, but you forget to replace him as the policy beneficiary? In that case, your ex-spouse will receive the policy proceeds, no matter how many years you have been divorced.

It’s easy and relatively painless. Updating or establishing beneficiaries is one of the easiest parts of estate planning. Start by making a list of your accounts, which you should have anyway and contact the account custodian to find out who is listed as a beneficiary. If no one has been named, get directions on how to establish the beneficiary designation and if possible, name a secondary beneficiary.

If you have an IRA or a 401(k), your account will typically offer a beneficiary form within the account. If you have investment accounts, you’ll need to request a form from the custodian.

Special rules for retirement account beneficiaries. There are rules about leaving retirement plan assets to a spouse, so if you want to leave those assets to children or grandchildren, your spouse will have to sign off on that, with a waiver. Depending upon where you live, a spouse may be entitled to have of the assets in an IRA, even if other beneficiaries are listed, unless there is written consent.

Reference: The Street (June 12, 2020) “Why You Should Add Beneficiaries to Your Investment Accounts Now”