SECURE Act: IRA Contributions and Charitable Distributions by 70+ Somethings
The SECURE Act ended the prohibition against IRA contributions after age 70½. It also preserved the ability to make qualified charitable distributions (QCDs) at age 70½ even though the required minimum distribution age was bumped to 72. Should post-70½-somethings start making IRA contributions? Should those age 70½ and 71 stop making QCDs?
IRA contributions are conditioned on earning compensation during the contribution year. Many retirees do not earn compensation after age 70, but some do. Compensation for this purpose includes free-lance income, as well as a spouse’s compensation.
Why would a retiree earner want to save for retirement?
Although it is clear why a retiree might need to keep working in our mostly post-defined benefit plan world, one might wonder why a retiree would want to continue making IRA contributions. One reason might be that if a retiree is still earning compensation, the retiree may not actually be retired. But even for someone who is only mostly retired, there is a mix of the usual reasons and special reasons to make IRA contributions for as long as possible.
Saving for beneficiaries. Even if a retiree is not particularly worried about saving for his or her own retirement, the retiree might want to put money away in a tax deferred IRA for their spouse, child or other beneficiary. An IRA with a natural person as a beneficiary is easy way to pass on assets outside of the probate estate.
Saving for old age. Retiree earners run the same risk as everyone else of outliving their money. Indeed, they have a head start on that so they might be particularly motivated.
Reducing taxable income. To a point, two of the other mainstays of retirement income – social security and capital gains–are subject to reduced or no income tax provided income is kept below certain income thresholds. Deductible IRA contributions can help adjust income downward.
Offsetting current year RMDs. Even in years when the owner must take RMDs, contributing to the IRA in the same year would cushion the effect.
EXAMPLE. Anna has to take $50,000 from her IRA in required minimum distributions for 2020. She works part-time earning $20,000 per year. She makes a deductible IRA contribution of $6,000 for 2020. Her net distribution from her IRA for 2020 is $44,000.
Employer plans no longer only option for retiree savings
Historically, only retirees who continued to work for an employer with a retirement plan could keep making tax deferred contributions. That is no longer the case with the elimination of the IRA age limit.
Example. Mary Ann is age 72 in 2020, and earns $20,000 as a freelance writer. She does not have a solo 401(k). She can now make IRA contributions of up to $7,000 (including a $1,000 catch up amount).
Comment: An IRA owner is subject to RMD requirements starting April 1 of the year following the year the owner attains age 72 (or age 70 ½ for individuals turning age 70 ½ before 2020). Note that an employer plan offers the advantage of no RMDs until the employee severs employment even if the employee is older than age 72. This rule holds as long as the employee does not own 5 percent or more of the employer.
Go wild. Retirees who qualify can make both kinds of contributions for the same tax year, though plan participants have to watch income limits for deductible IRA contributions.
EXAMPLE. Joe is age 72 and earns $40,000 in 2020 working for a large corporate employer. He participates in his employer’s 401(k) plan under which he can contribute up to $19,500 plus $6,500 in catch-ups. Under the new rule, he can also make deductible IRA contributions of up to $7,000 (including a $1,000 catch up contribution).
Retiree givers: RMD-less Qualified Charitable Distributions (QCDs)
Starting the tax year an individual turns age 70½, an individual can use QCDs to contribute up to $100,000 each year to a qualified charity. Distributions are not taxed, and the contribution does not have to be deducted as a charitable donation. Plus, distributions count as required minimum distributions. The SECURE Act made two changes that affect QCDs.
Running Offset Against QCD for Post-70½ IRA Contributions
First, an individual who makes a deductible IRA contribution after age 70½ will reduce the amount of available QCD by that amount. This reduction is not just for the year of the contribution. It is cumulative, and it carries forward.
Comment: This treatment of post-70½ deductible IRA contributions might be a trap for the unwary who one day decide to make a QCD only to find the distribution taxable. At the very least, it calls into question the wisdom of making post-70½ deductible IRA contributions if one plans on making QCDs. Roth IRA or nondeductible IRA contributions would not affect QCDs in this way.
Awkward age for QCDs.
The second SECURE Act change affecting QCDs is that required minimum distributions begin for the year an individual turns age 72 rather than age 70½. Interestingly, the minimum QCD age remains age 70½. This change raises the question whether it is worth doing a QCD for someone in the tax year or years between attaining age 70½ and 72?
Comment: A big advantage to doing a QCD rather than a taxable IRA distribution coupled with a deductible charitable contribution Code Sec. 170 is that a QCD is not subject to percentage limitations or the general limits for itemized deductions. So there is much to be said for QCDs for the charitably minded even if the distribution does not count for RMD purposes.
The case for waiting until age 72
Reducing an IRA balance in a tax-free way can make sense at any time, but for people who worry about RMDS it makes sense to wait until age 72 when a QCD can soak them up.
Example 1. Cynthia turns age 70 ½ in June 2020. Because she turns that age in 2020, she does not have to begin required minimum distributions until she turns age 72 in 2022. Cynthia has $1 million in her IRA that she has earmarked for charity. There is a strong case for starting QCDs early because annual amounts cannot exceed $100,000, plus her plan dedicates the entire balance to charity.
Example 2. Morris also turns age 70 ½ in June 2020, and he also has $1 million in his IRA. He would like to make some charitable contributions, but he primarily wants to pass on significant amounts to his surviving spouse and children. He should hold off making any QCD until he must take RMDs.
Comment: Unlike Cynthia whose main goal is to target her IRA balance for charity in a timely way, Morris’s goal of preserving this IRA balance suggests that any QCD should do double duty.
As has been amply reported, the SECURE Act pushed initial RMDs back from age 70½ to age 72. Less well publicized is that age is no longer a limit on our IRA contributions. Deductible contributions can make a lot of sense for individuals who are still earning compensation.
Individuals can still make QCDs at age 70½ and 71, even though they do not count as RMDs. Although QCDs can still make sense for some in these in-between years, their value is weakened for most IRA owners for those years.
By James Solheim, J.D.