The Setting Every Community Up for Retirement Enhancement (SECURE) Act set a trap for the unwary when it comes to post-70 ½ IRA contributions. The Act ended the age 70 ½ limit on IRA contributions, which is good. Taxpayers need to know, however, that post-age 70 ½ IRA contributions can lower the maximum for qualified charitable distributions (QCDs). Timing counts.
Before the SECURE Act, Turning Age 70 ½ Was a Big Deal
Prior to the SECURE Act, three IRA rules operated together to turn IRAs from a retirement savings device to a retirement income device. These rules went into effect all at once the year a taxpayer turned age 70 ½. These rules include the following:
- IRA contributions were no longer allowed;
- Required minimum distributions (RMDs) had to be taken for that year (with a delayed required beginning date of April 1 of the following year for the first RMD); and
- Deductible qualified charitable distribution (QCD) became allowable for up to $100,000 per year which would count against any current RMD obligation.
Basically, taxpayers could not make new contributions, and had to start distributing money out of existing IRA balances. The charitably minded, however, had the option of transferring IRA dollars directly to a charity which avoided taxation and counted against any RMD obligations.
Comment: Under this all-at-once approach, there was no tax incentive to time QCDs or IRA contributions.
After the SECURE Act, Only One Thing Changes at Age 70 ½
Under the SECURE Act, taxpayers who attain age 70 ½ in 2020 or later do not have to take RMDs until the year they turn age 72 (with a required beginning date the following April 1).
Also, a taxpayer who turns age 70 ½ does not have to stop making IRA contributions if the taxpayer otherwise qualifies. Note that this change applies to anyone who has already turned age 70 ½, no matter when that was.
Window for RMD-less QCDs. The one thing that does still change at age 70 ½ is the ability of taxpayers to make QCDs. For the year or two (depending on the taxpayer’s birthday) between the year the taxpayer turns age 70 ½ and the year the taxpayer turns age 72, there are no RMDs. Therefore, one of the incentives for making QCDs is missing for that year or two.
Example. Arthur turns age 70 ½ in 2020 and age 72 in 2022. Under the SECURE Act changes, he can make QCDs starting in 2020, but RMDs do not apply until 2022 (with a required beginning date of April 1, of 2023).
Comment. There are other reasons to make QCDs besides soaking up RMDs. They are an excellent way to avoid paying tax on IRA distributions, benefit a charity, and avoid any charitable deduction limits.
Comment: Many taxpayers are not that concerned about RMDs either because they need to take the distributions anyway for living expenses, or because they are super-wealthy. But for those in the middle who would strongly prefer to avoid RMDs, waiting until the year they turn age 72 to make any QCD makes a lot of sense.
Qualified Charitable Distribution Trap
Although age 70 ½ remains the start date for QCDs, the SECURE Act added a twist. Allowable QCD amounts are reduced for any year by the amount of current or prior post-age 70 ½ IRA deductible contributions. These amounts are carried forward until used up. Note that IRA contributions after a QCD are not carried back.
Example. Bea turned age 70 ½ before 2020. She deducts $5,000 for contributions for each of 2020 and 2021, but makes no contribution for 2022. Bea makes no QCDs for 2020, but makes QCDs of $6,000 for 2021, and $6,500 for 2022.
2021. The excludable amount of QCD for 2021 is the $6,000 of distribution reduced by the $10,000 aggregate amount of post-age 70 ½ contributions for 2021 and earlier tax years. For Bea, these amounts are $5,000 for each of 2020 and 2021, resulting in no excludable amount of QCDs for 2021 (that is, $6,000 – $10,000 = ($4,000)).
2022. Bea’s excludable amount of the QCDs for 2022 is the $6,500 of 2022 distribution reduced by the unused portion of the $10,000 aggregate amount of post-age 70 ½ contributions deducted that did not reduce the excludable portion of the QCDs for earlier tax years.
Thus, $6,000 of the aggregate amount of post-age 70 ½ contributions deducted does not apply for 2022 because that amount has reduced the excludable amount of qualified charitable distributions for 2021. The remaining $4,000 of the aggregate amount of post-age 70 ½ contributions deducted reduces the excludable amount of any QCDs for subsequent tax years. Accordingly, the excludable amount of the QCDs for 2022 is $2,500 ($6,500 – $4,000 = $2,500).
Because the $4,000 amount reduced the excludable amount of QCDs for 2022, that $4,000 amount does not apply again in later years, and no amount of post-age 70 ½ contributions remains to reduce the excludable amount of QCDs for subsequent tax years.
Comment: Taxpayers who want to make near the maximum of allowable QCDs will want to hold off on post-age 70 ½ IRA contributions until they are done making QCDs.
This rule is designed to prevent taxpayers from routing post-age 70 ½ contributions through an IRA to make an unusually tax-friendly charitable contribution. It is unclear why exactly post-age 70 ½ contributions should be treated differently from pre-age 70 ½ contributions for this purpose, however.
IRA Contributions and RMD Offsets
Contributing to an IRA in the same year one has to take RMDs can cushion the effect if one did not need or want the RMDs. The IRS has made it clear, however, that RMDs and contributions may not be literally offset.
Example: In 2021, Hadley wants to reduce her $10,000 in RMDs by $6,000 by contributing to an IRA. She deposits her $10,000 RMD check. She separately writes a check for $6,000 for an IRA contribution. Each transaction is reported independently. Although her net RMD is $4,000, she cannot simply take a $4,000 distribution and call it a day.
The SECURE Act’s elimination of the IRA contribution end-date, and the breaking apart the RMD and QCD start-dates should on the whole bolster post-age 70 ½ IRA balances. Taxpayers must be careful, however, not to carelessly squander RMD opportunities through early QCDs, or reduce allowable QCDs through post-70 ½ IRA contributions.
By James Solheim, J.D.