Case:

Quentin was the firstborn child in a large family. Throughout his childhood, Quentin’s parents worked hard to put food on the table for their children. They also instilled in Quentin the value of hard work and saving money. Quentin took those lessons to heart, putting forth his best efforts in school, finding a rewarding job and increasing his savings. For many years, Quentin worked for a company that offered a 401(k) plan. During those years, he put as much into his 401(k) as he could to maximize the benefit of his employer’s matching contributions. Eventually, Quentin moved on to other employment and made a tax-free rollover of his 401(k) into an IRA. As he approached retirement, Quentin continued to invest in his retirement savings by maxing out his IRA contributions each year.

With his lifelong penchant for saving money and some savvy investing, Quentin was able to retire comfortably at age 65. Now in his early 70s, Quentin realizes that at age 73 he will be taking required minimum distributions (RMD) from his IRA. Given his lifetime savings, investment income and social security distributions, Quentin does not feel he needs the additional income that the IRA distributions will provide – especially with the increased taxes tied to that income.

Question:

Quentin has previously discussed with his advisor the possibility of donating to a donor advised fund (DAF). He likes the idea of making a charitable gift now and having the flexibility to advise on gifts in the future to charities of his choice from the DAF. Quentin wonders if a DAF would be a good fit to receive his IRA charitable rollover gift. Before contacting his IRA custodian, Quentin decides to give his advisor a call to see if this is the best strategy for him.

Solution:

Quentin’s advisor is relieved to hear that Quentin called before directing a qualified charitable distribution (QCD) to a DAF. Section 408(d)(8)(B)(i) expressly excludes Sec. 4966(d)(2) donor advised funds from being qualified recipients of an IRA charitable rollover gift. If Quentin’s IRA were to distribute to a DAF, Quentin would be taxed on the distribution, and his DAF contribution would be treated as a cash contribution. If Quentin were to structure the IRA distribution this way, he would receive an income tax deduction for the gift to the DAF, because the distribution would be included in his taxable income. While the deduction may offset the taxation, this arrangement could cause several tax issues for Quentin. First, it may bump him up to a higher income tax bracket. Second, if Quentin is a non-itemizer, he may not benefit from the income tax deduction. Third, if Quentin does itemize, he is subject to deduction limits. For charitable gifts of cash, a taxpayer may deduct up to 60% of adjusted gross income (AGI) in the current tax year. A taxpayer who has reached the deduction limit may carry any unused deduction amount forward for up to five additional years. After learning about the possible tax consequences of being taxed on his IRA withdrawal, Quentin decides not to fund a DAF with his IRA. Instead, he makes an IRA charitable rollover gift to his favorite charity.