Using Required Minimum Distribution Rules to Benefit Charities

According to the AARP, about 10,000 Americans turn 70½ every day of the year. If you’re in that group, and have money parked somewhere that you’ve identified as a retirement account, get ready to start making withdrawals if you’ve not yet done so. We’re talking about Required Minimum Distributions or RMDs.

Some of you reading this may not need the money you’re required to withdraw. Some of you may be ticked off because it causes you to pay extra income taxes. But that won’t stop the IRS from assigning you a penalty if you don’t comply. So here’s an idea to consider.

Many of us have social causes that we appreciate and favor with a gift of money from time to time. How about directing your RMD, to one of those causes. You satisfy the IRS and get a tax deduction equal to the withdrawal. This removes the pain of having to take money from the account and satisfies your desire to promote the welfare of a not-for-profit (NFP) enterprise. Just make sure it’s a properly defined NFP, otherwise your gift will not qualify for a tax deduction.

Personally, I’m a founding director of a Community Foundation that encourages people to establish what are known as Donor Advised Funds (DAF). The Foundation is a properly created NFP that accepts gifts. A DAF is one where you as the donor can direct just where and how much of your gift should be granted. Once established, there are minimums funding levels, but it creates the potential for gifts in perpetuity to causes that you favor.

Here’s some further background information. The Internal Revenue Service (IRS) is responsible for describing and collecting federal taxes from us. It’s up to us to know the rules and to conform to them to avoid penalties. Alternatively, if we are so motivated, we can attempt to argue our position in the Tax Court. Our chances of winning a legal battle over RMDs is slim to none.

IRS rules say that if we have money accumulating in properly defined accounts such as an IRA, a 401(k), a 403(b), or any one of several similarly identified accounts, income taxes on that money has not yet been paid. Those taxes were deferred until later and are thought of as ‘qualified’ money. That term results from rules that made this money ‘qualified’ for tax deferral in the tax year it was earned. Accounts containing money that has been taxed as income when it was earned are called ‘non-qualified’ accounts.

It’s also the position of the IRS that given their responsibility to collect taxes to keep the federal coffers properly filled, they have the ability to impose penalties if you don’t conform to the rules. Which is why you need to understand RMDs so as to not make the IRS angry.

The original intent of ‘qualified’ accounts was to incentivise people to set aside money from current income and let it accumulate to help pay for retirement. They then added penalties if you took it too soon and penalties if you failed to withdraw money later on. While somewhat arbitrary, the ‘too soon’ age is before you reach 59½ and the failure to withdraw age is 70½.

Since you presumably know your birth date, it’s not hard to figure out the calendar year when you reach age 70½ . That calendar year defines the tax year when, if you don’t take out the MINIMUM amount and pay taxes on it, you’ll make the IRS angry. There’s little to be gained from that.

One caveat is that if you turn 70½ in tax year 2019, for example, you actually have until April 1st of 2020 to take your REQUIRED MINIMUM and report it as income. That may give you a little breathing room, but it also means you’ll have a second RMD to deal with in 2020. Every year after that first year, the formula for your RMD means money has to be taken before December 31st to avoid a penalty.

With the internet now available to virtually all of us, it’s not hard to find an online calculator to tell you how much you have to take. There is a variation you need to be aware of, however, if you have IRAs and 401(k)s.

If you have multiple IRAs, you can aggregate them and have the RMD apply to the aggregation amount. That means the IRS doesn’t care which account the RMD comes from, just that the RMD shows up as income on your tax return.

If you have one or more 401(k) accounts, you need to calculate the RMD for each and make the appropriate withdrawal from each. If you’re still working and contributing to that 401(k), you can delay your RMD until you stop working. Unless you own 5% or more the company, in which case you cannot delay.

Another rule is you don’t necessarily have to take an RMD in cash. It’s the amount that shows up on your tax return that matters. You may have stock positions in a 401(k) account, so you might instead transfer some of those positions to a non-qualified account and satisfy the IRS.

If you discover after the fact that you failed to take a timely RMD, don’t just send the IRS a check. Fill out a form that describes your mistake, and they might just waive the penalty.

Lastly, it’s easy to get confused if you are not financially sophisticated. I’ve had clients who get all caught up in the age 70½ and RMD rules. They get confused and ask if they can wait until 70½ to sign up for Social Security. Yes, they can, but why would you forfeit six months of Social Security benefits that cannot be recovered.

Tony Kendzior \ September 25, 2019