The Q Means Quagmire

The Individual Retirement Account (IRA) falls under the IRS category of “qualified plans.” The qualification is special income tax treatment. We get to invest money and reduce our income tax. The advantage to the IRA is that the investments grow tax-deferred, and you can begin penalty free withdrawals as early as age 59 ½.  A great deal, but there is a caveat. After we reach age 72 (new rules) and each year thereafter, we must take a Required Minimum Distribution (RMD) from the IRA by December 31. (Note: there is a waiver this year because of Covid). Failing to withdraw the funds from our IRA results in a 50% penalty from the IRS.

Enter the quagmire. For example, Ruth is 80 years old and has an $600,000 IRA and her RMD this year is $32,000. Missing the December 31 deadline could mean a $16,000 tax bill. Horrible, but it gets worse. Imagine you are Ruth’s only child and you learn after Ruth died that she made her estate the beneficiary of her IRA. Had she named you, the IRA could have been distributed over ten years – roughly $60,000 per year. This will probably place you in the next income tax bracket. Instead, you receive a $600,000 lump sum distribution placing you squarely in the highest income tax bracket. That wrong beneficiary designation cost about $78,000!

The good news is that the quagmire has a silver lining. After age 70½, Ruth can make charitable gifts from her IRA. The IRS permits a Charitable IRA Rollover gift made directly to a qualified charity – up to $100,000 each year. So, if Ruth gifts half her RMD to her church, she has reduced the income by $16,000, and thus lowered her tax bill. This is great news for people over 70 ½.

As 2020 comes to an end, there is still time to make a gift from your IRA. To learn more about the Charitable IRA Rollover, CLICK HERE