New tax break now available for older savers in IRA donation

Personal Finance

December 10, 2006|By Eileen Ambrose | Eileen Ambrose,Sun Columnist

Older savers have a new tax break that allows them to make tax-free withdrawals from individual retirement accounts if the money is donated directly to charity.

Charities for years have pushed for such a tax break. Still, when Congress included it in the Pension Protection Act in August, many financial institutions were caught off guard.

The tax break took effect immediately. And with little governmental guidance, charities and financial institutions scrambled to figure out the mechanics.

"It's new, and therefore, there is confusion," said Harry Rubins, a financial consultant in Santa Rosa, Calif.

The tax break, available only this year and next, allows those 70 1/2 or older to donate up to $100,000 a year directly from an IRA to a charity without paying regular income tax on the withdrawals.

(After age 70 1/2 , individuals must begin taking minimum distributions each year from a traditional IRA. Any charitable donations from an IRA count toward these required distributions.)

The tax perk is expected to appeal to wealthy individuals who don't need the money to live on. But even those with moderate incomes who regularly give to charity can benefit, too, said Ed Slott, an IRA expert in Rockville Centre, N.Y.

Plus, charitable donations from IRAs can have a positive impact on other parts of your tax return, Slott added.

The charitable distributions won't boost adjusted gross income as do regular withdrawals from a traditional IRA.

"Generally, all your deductions, credits and exemptions are all pegged to AGI," Slott said. "If you lower AGI, you are going to have lower taxes."

For instance, a lower income level can make it easier to meet the thresholds for deducting medical or miscellaneous expenses. It might also reduce the amount of Social Security benefits that are taxed, Slott said.

(It doesn't make sense to make donations from a Roth IRA because distributions aren't taxed, experts said.)

Before tapping your IRA for charity, make sure you know the rules. Any missteps by you, the charity or the IRA custodian could disqualify you.

"There are some traps out there," said Richard Fox, a lawyer and an associate professor at American College in Pennsylvania.

Donations can't be made to donor-advised funds, private foundations or supporting organizations affiliated with a public charity. And it's up to donors -- not the IRA custodian -- to make sure the money goes to a qualified charity.

The donation must be made directly from the IRA to the charity. You can't, say, have a check made out to you, and then write a check to the charity.

"That would make it taxable," said Robert Sharpe, a Memphis, Tenn., financial adviser to nonprofits. "There is no way out of that."

Some IRA custodians are sending checks directly to the charity so that donors never touch the check. Others will cut the check in the name of the charity, but mail the check to the donor to forward. Either way is fine, said Jennifer Zuccarelli, a Treasury Department spokeswoman.

Donors can't receive any benefit in return for their gift. So, if your alma mater treats you to a dinner or sends you football tickets for making a donation, there goes your tax-exempt withdrawal.

(If donors run afoul of the rules and lose the tax exemption, they could report the IRA distribution as income and deduct the gift on their itemized return as usual. )

Before making a gift, contact the charity and the IRA's custodian.

Custodians don't have to allow charitable distributions, although most are expected to do so, experts said.

"Custodians are free to set their own rules," Fox said.

Some might balk, say, at sending $50 to 2,000 charities, he said.

T. Rowe Price Associates, for example, requires that charitable distributions be at least $500. Mellon Financial Corp. and the Vanguard Group have no limit.

You might have to fill out forms or write a letter of instruction.

If you write a letter, tell the custodian you want to make a charitable donation from an IRA as permitted under the Pension Protection Act, experts said. Include the amount of the gift, the charity's name, address and, if available, its tax identification number.

If the check is being mailed directly to the charity, include the name and number of someone at the charity who can be contacted if the custodian has questions. Also, the custodian should note in the memo area of the check or elsewhere that the check comes from you, experts said.

Charities also need to be alerted that a gift is on the way, experts said.

You should request a letter from the charity acknowledging the gift. That letter should verify that the organization is a qualified charity and that you haven't received anything in return for your contribution, said Jere Doyle, a Mellon senior vice president in Boston.

One of those eyeing the potential tax benefit is Ted Nelson, 72, a retired microwave engineer in Ellicott City. He plans to make a donation from his IRA to his old schools early next year.

"I have to take a certain amount out each year, but if I donate something to my high school and college, that's not taxed," he said. Nelson and his wife, Pat, figure that they will save about $3,000 in taxes.

"I would like to see it extended" beyond next year, said Pat Nelson, who is 63.

She may get her wish.

Some financial experts predict that Congress will extend the tax break for more years and possibly open it up to younger IRA owners and more types of charities.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose

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