IRA Giving Strategies

July 20, 2022

Since the 1970’s, employers have slowly been leaving the older pension-style retirement plans (called defined benefit plans) and cycling into plans that allow employees to determine how much of their compensation they want to save for retirement (defined contribution plans).  Employees don’t know exactly how much they will get every month in the distribution phase like they did from a pension, but they do define how much they contribute.  Ergo the name “Defined Contribution”.  

Fast forward into the 1990’s and the relationship between employee and employer has undergone a drastic change.  What, for the golden generation and many baby boomers started as a lifelong employee-employer relationship, became more of a business arrangement.  Very seldom does an employee work anywhere for their entire adult life, which used to be commonplace in the post World War II era.  Today, workers tend to change employers several times over their working life and employers have come to accept that turnover is part of running a business.

All these societal changes have led us to a place where the IRA (Individual Retirement Arrangement) has become the dominant holder of retirement assets.  People work for a number of years at a particular place, contribute to their employer-sponsored plan, and leave.  When they sever service, they generally roll those accumulated funds into an IRA. 

Some of those people that are particularly lucky do not need some (or any) of their IRA assets to finance their retirement.  They want to either leave this money to their children or see it donated to their favorite church or charitable organization. 

Those situations are where effective distribution planning can truly shine.  You see, any distributions made from a traditional IRA are considered fully taxable to the owner for the year in which they are taken.  There are a few exceptions, but that’s the rule. 

Thankfully, there are some really useful concepts that can mitigate or even eliminate taxes from IRA distributions, from Roth conversions to Qualified Charitable Distributions to spread-liability distribution strategies. 

Roth IRA conversions can be done over a series of years and are a proven method to reposition traditional IRA funds into a Roth-style account.  While the money converted has to be declared as income, any future growth happens in a Roth IRA and is nontaxable.  When spread out properly, the income tax liability from the original conversion can be managed to avoid the worst of the tax liability. 

Spread-liability distributions are similar and can be used to fund life insurance or as a gifting strategy directly to heirs.  The idea from the conversion above is the same.  Take IRA distributions out over a period of years, which spreads tax liability.  Subsequently, either fund a properly structured life insurance policy which has no income taxes on death benefits paid out, or directly gift the funds to heirs.  Gifts under the IRS approved amount do not have to be declared by the recipient on their tax returns.

Qualified Charitable Distributions are completely unique.  IRA holders can give funds from their account directly to any tax-qualified nonprofit organization and never declare it as income at all.  The funds are sent directly from the donor’s account to the charity.  For those that give regularly to charities anyway, this method is extremely effective. 

Keep in mind, you still have to be over 59 ½ to take penalty-free distributions from an IRA in most cases.   The above strategies are all referring to post-59 ½ distributions. 

Saving money is hard.  Saving enough money to finance your retirement and still leave assets to others is even harder.  Use the strategies available to you to make the most of your efforts.

*A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.