Past Age 70.5 Traditional IRA Contributions Can Result in ‘Taxable’ Qualified Charitable Distributions Under SECURE Act

One of the provisions resulting from the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019 was that effective Jan. 1, 2020, there is no longer an age limit for individuals for contributing to a traditional IRA. Pre-SECURE Act passage, the individual age limit for contributing to a traditional IRA was age 70.5.

It is important to keep in mind one of the requirements for an individual to contribute in any year to any type of IRA – a traditional IRA and/or a Roth IRA – is that the individual or if married, the individual’s spouse – must have some type of “earned income” (salary/wages or net profit from self-employment) that year.

What the SECURE Act traditional IRA law change means for federal employees is that any federal employee – including those employees over age 70.5 – is eligible to contribute to a traditional IRA (starting in tax year 2020) as much as $6,000 ($7,000 if the employee is over age 49). A married federal annuitant no matter his or her age and whose spouse is still working would also be eligible to contribute to a traditional IRA starting in tax year 2020.

Note that although the IRS extended the 2019 income tax filing deadline until July 15, 2020 and that the deadline for making 2019 IRA contributions has also been extended until July 15, 2020, individuals over age 70 and older during 2019 and with earned income during 2019 cannot make 2019 traditional IRA contributions.

While the SECURE Act did eliminate the age limit for contributing to a traditional IRA, as well as raise the age for required minimum distributions (RMDs) for traditional IRAs from age 70.5 to age 72, the SECURE Act did not alter the starting age for making Qualified Charitable Distributions (QCDs).

A QCD is a withdrawal of funds from a traditional IRA with the intention of donating the IRA funds directly to a qualified charity. There are tax benefits associated with QCDs, the most important of which is using the QCD to fulfill some, or all, of the traditional IRA owner’s annual RMD requirement. These tax benefits are discussed below.

Rules for making Qualified Charitable Distributions

In order to make a QCD, an individual must meet the following requirements:

(1) Be at least age 70.5;

(2) own a traditional IRA; and

(3) contribute directly from the traditional IRA no more than $100,000 in any calendar year.

QCDs can be made to multiple charitable organizations. These charitable organizations must accept tax-deductible contributions; that is, the charitable organization must be a 501(c)(3) approved organization. A QCD can only come directly from the traditional IRA.

A QCD that is made before December 31st can be used to satisfy part or all of a traditional owner’s RMD (normally, included in the traditional IRA owner’s taxable income) for the year. In performing a QCD, the traditional IRA owner does not have to include the IRA withdrawal (distribution) in the owner’s taxable income for the year. In other words, the traditional IRA owner does not increases his or her federal and state income tax liabilities for the year by making a QCD while simultaneously satisfying some or all of his or her annual traditional IRA RMD requirement.

Post-age 70.5 deductible traditional IRA contributions and QCDs

For those federal employees and annuitants who are post-age 70.5 and who, starting in 2020 make deductible contributions to traditional IRAs (a deductible contribution to a traditional IRA shows up on IRS Form 1040, Schedule 1, Part II, as an “adjustment to income”), the SECURE Act limits the portion of a future QCD that is excluded from income, effectively creating in effect a “taxable” QCD. The maximum amount of a QCD that will qualify towards meeting the IRA owner’s traditional IRA RMD is equal to the year’s QCD minus the cumulative amount of the owner’s post-age 70.5 traditional IRA deductible contributions. The resulting amount is the amount of traditional IRA RMD excludable from income.

The following examples will help illustrate:

Example 1.

Randy, age 70, will retire from federal service on Aug. 31, 2020. Randy also plans to directly transfer his traditional TSP currently with $850,000 to a traditional IRA shortly after he retires. Randy plans to work for a consulting firm, starting in early 2021. For the period from 2021 – 2026, Randy intends to continue working and contribute $7,000 each year to his traditional IRA until Randy officially retires at age 76. Six post-age 70.5 deductible traditional IRA contributions of $7,000 each (for the years 2021-2026) are made for a total of $42,000 in traditional IRA contributions. Randy has never done a QCD.

When Randy becomes age 80 in 2030, his traditional IRA RMD is $50,000. He therefore requests a $50,000 QCD be sent directly to a local art museum. Randy’s previous deductible post-age 70.5 contributions of $42,000 carry forward and consume an equal amount of the QCD. This means that of Randy’s $50,000 QCD, $42,000 was contributed with pre-taxed dollars; therefore, only $50,000 less $42,000 or $8,000, can be used to offset Randy’s $50,000 traditional IRA RMD and excluded from Randy’s 2030 taxable income. The remaining $42,000 of the RMD is taxable income to Randy in 2030.

Example 2.

Brian, age 70, is a federal annuitant and is married to Susan, age 65, who works in private industry. Brian has transferred his entire TSP account to a traditional IRA. Since Brian was born in 1950, his traditional IRA is not subject to a RMD until the year 2022. Brian has until April 1, 2023 to make his 2022 traditional IRA RMD. In the meantime, Brian intends to contribute to a deductible traditional IRA based on the fact that his wife, Susan, is still working. For the years 2020, 2021 and 2022, Brian intends to contribute $7,000 each year, for a total of $21,000 to his deductible traditional IRA. On December 31, 2021, Brian’s traditional IRA is worth $530,000. Brian’s first traditional IRA RMD for 2022 is due by April 1, 2023 and is equal to:

$530,000 (IRA value as of 12/31/2021)/25.6, or $20,703

Since Brian contributed a total of $21,000 (using pre-taxed dollars) to his traditional IRA post-age 70.5, none of the $21,000 can be used as a QCD in order to offset the $20,703 traditional IRA RMD, meaning that the full $20,703 will be included in Brian’s 2023 taxable income when he takes his 2022 traditional IRA RMD in February 2023.

In summary, examples 1 and 2 illustrate the situations in which Randy and Brian are unable to use some or all of their QCDs to offset their traditional IRA RMDs. Both situations could have been avoided by Randy and Brian skipping post-age 70.5 deductible traditional IRA contributions and instead making Roth IRA contributions (which, among other advantages, are not subject to RMDs). As a means of offsetting their traditional IRA RMDs and assuming that Randy and Brian itemize on their federal income tax returns (that is, they file Schedule A), they could offset their RMDs “dollar-for-dollar” by making a direct charitable contribution, writing a check from their personal non-retirement savings to a qualified charitable organization for the amount of their RMDs.

Federal employees and annuitants should be aware of the disadvantage of making post-age 70.5 traditional IRA contributions with respect to QCDs. In particular, how post-age 70.5 traditional IRA contributions can reach through the years and take away all or a portion of a future QCD, thereby taking away the advantage of a QCD fulfilling a traditional IRA RMD requirement and avoiding the RMD income inclusion.