Take a Tax-Free Distribution From Your IRA

In August, 2006, Congress gave us another minor piece of tax legislation - 900 pages of a law known as The Pension Protection Act of 2006. This legislation makes some substantial changes to the rules related to distributions from Individual Retirement Accounts (IRAs). Although many of the changes are extremely complex, there are some fantastic tax saving and estate planning opportunities. I will discuss some of these here and there over the next few months.

There is a change that provides a limited opportunity to make a contribution to your favorite charity for the years of 2006 and 2007 only. Since the law was passed so late in 2006, there is not much time to take action before the end of the year.

The law requires you be at least 70 1/2 at the time of the contribution in order to take advantage of this provision. If you are younger, consider passing this suggestion on to others who may qualify such as your parents, relatives or friends. It is an easy way to minimize some potential estate taxes down the road and provide some current tax benefits.

If you have attained the age of 70 1/2 by the time of the contribution, you may make a charitable contribution DIRECTLY from your IRA to a charity. If you choose to do so, then the amount withdrawn from your IRA to make the contribution will not be included in your taxable income. Likewise, you will not receive a charitable contribution deduction.

Why would you consider this type of transaction? When you are age 70 1/2, you are required to make minimum distributions from your IRA each year. Often, people do not really need the money, but they are required to take the distribution and pay the taxes anyway. So, they are really just moving money from one account to another and paying taxes for that privilege. Often these same people are making substantial charitable contributions.

One big advantage is that the money you take out to donate can be the amount of your required minimum distribution. By handling the transaction in this manner, you can reduce the taxes you may otherwise pay on your Social Security income. If your income is not high enough to take a large charitable contribution deduction in any given year due to the limitation on the deductible amount for charitable contributions, you are not penalized. Please note that while the limitation is $100,000, donations of any amount will work. In some cases, you may just want to contribute the amount of your required minimum distribution which may even be $1,000 or less.

In order for this transaction to work, very specific rules must be followed. The transfer from the IRA to the charity must be made DIRECTLY from the IRA trustee to the charity. If the IRA money is distributed to you so you can personally deliver it to the charity, the transaction WILL NOT QUALIFY. Most of your standard charities such as churches, schools and other organizations qualifying for a charitable contribution deduction are eligible for this transaction. However, there are a few organizations which will not qualify.

The other big caveat here is that you cannot receive any type of benefit from the charity in return for your contribution. So, if you are making a contribution to public television, for example, and they send you a recording of a show (worth all of $25), the entire $100,000 transaction will be disqualified.

If you would like to try this type of transaction, but your money is in a 401(k) plan, instead of an IRA, then you could roll some money into an IRA and then complete the transaction.

If you are interested in pursuing this tax planning strategy, please contact me, and I will provide you with further information.