The considerations involved in deciding whether to make a direct IRA rollover have changed in light of the Tax Cuts and Jobs Act (TCJA). If you’re age 70½ or older, you can make direct contributions — up to $100,000 annually — from your IRA to qualified charitable organizations without owing any income tax on the distributions. This break may be especially beneficial now, because of TCJA changes that affect who can benefit from the itemized deduction for charitable donations.

Counts Toward Your RMD
A charitable IRA rollover can be used to satisfy required minimum distributions (RMDs). You must begin to take annual RMDs from your traditional IRAs in the year you reach age 70½. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (Deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)

So if you don’t need the RMD for your living expenses, a charitable IRA rollover can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid to you.

Doesn’t Require Itemizing
You might be able to achieve a similar tax result from taking the RMD and then contributing that amount to charity. But it’s more complex because you must report the RMD as income and then take an itemized deduction for the donation.

And, with the TCJA’s near doubling of the standard deduction, fewer taxpayers will benefit from itemizing. Itemizing saves tax only when itemized deductions exceed the standard deduction. For 2018, the standard deduction is $12,000 for singles, $18,000 for heads of households, and $24,000 for married couples filing jointly.

Doesn’t Have Other Deduction Downsides
Even if you have enough other itemized deductions to exceed your standard deduction, taking your RMD and contributing that amount to charity has two more possible downsides.

First, the reported RMD income might increase your income to the point that you’re pushed into a higher tax bracket, certain additional taxes are triggered and/or the benefits of certain tax breaks are reduced or eliminated. It could even cause Social Security payments to become taxable or increase income-based Medicare premiums and prescription drug charges.

Second, if your donation would equal a large portion of your income for the year, your deduction might be reduced due to the percentage-of-income limit. You generally can’t deduct cash donations that exceed 60% of your adjusted gross income for the year. (The TCJA raised this limit from 50%, but if the cash donation is to a private non-operating foundation, the limit is only 30%.) You can carry forward the excess up to five years, but if you make large donations every year, that won’t help you.

A charitable IRA rollover avoids these potential negative tax consequences.

Converting a traditional IRA to a Roth IRA can provide tax-free growth and tax-free withdrawals in retirement. But what if you convert your traditional IRA — subject to income taxes on all earnings and deductible contributions — and then discover you would have been better off if you hadn’t converted it? Before the Tax Cuts and Jobs Act (TCJA), you could undo a Roth IRA conversion using a “recharacterization.” Effective with 2018 conversions, the TCJA prohibits recharacterization — permanently. But if you executed a conversion in 2017, you may still be able to undo it.

Reasons to Recharacterize
Generally, if you converted to a Roth IRA in 2017, you have until October 15, 2018, to undo it and avoid the tax hit.

Here are some reasons you might want to recharacterize a 2017 Roth IRA conversion:

  • The conversion combined with your other income pushed you into a higher tax bracket in 2017.
  • Your marginal income tax rate will be lower in 2018 than it was in 2017.
  • The value of your account has declined since the conversion, so you owe taxes partially on money you no longer have.

If you recharacterize your 2017 conversion but would still like to convert your traditional IRA to a Roth IRA, you must wait until the 31st day after the recharacterization. If you undo a conversion because your IRA’s value declined, there’s a risk that your investments will bounce back during the waiting period, causing you to reconvert at a higher tax cost.

Recharacterization in Action
Sally had a traditional IRA with a balance of $100,000 when she converted it to a Roth IRA in 2017. Her 2017 tax rate was 33%, so she owed $33,000 in federal income taxes on the conversion.

However, by August 1, 2018, the value of her account had dropped to $80,000. So Sally recharacterizes the account as a traditional IRA and amends her 2017 tax return to exclude the $100,000 in income.

On September 1, she reconverts the traditional IRA, whose value remains at $80,000, to a Roth IRA. She will report that amount when she files her 2018 tax return. The 33% rate has dropped to 32% under the TCJA. Assuming Sally is still in this bracket, this time she’ll owe $25,600 ($80,000 × 32%) — deferred for a year and resulting in a tax savings of $7,400.

(Be aware that the thresholds for the various brackets have changed for 2018, in some cases increasing but in others decreasing. This, combined with other TCJA provisions and changes in your income, could cause you to be in a higher or lower bracket in 2018.)

Know Your options
If you converted a traditional IRA to a Roth IRA in 2017, it’s worthwhile to see if you could save tax by undoing the conversion. If you’re considering a Roth conversion in 2018, keep in mind that you won’t have the option for recharacterization. We can help you assess whether recharacterizing a 2017 conversion or executing a 2018 conversion makes sense for you.

Yes, there’s still time to make 2016 contributions to your IRA. The deadline for such contributions is April 18, 2017. If the contribution is deductible, it will lower your 2016 tax bill. But even if it isn’t, making a 2016 contribution is likely a good idea.

Benefits beyond a deduction

Tax-advantaged retirement plans like IRAs allow your money to grow tax-deferred — or, in the case of Roth accounts, tax-free. But annual contributions are limited by tax law, and any unused limit can’t be carried forward to make larger contributions in future years.

This means that, once the contribution deadline has passed, the tax-advantaged savings opportunity is lost forever. So it’s a good idea to use up as much of your annual limit as possible.

Contribution options

The 2016 limit for total contributions to all IRAs generally is $5,500 ($6,500 if you were age 50 or older on December 31, 2016). If you haven’t already maxed out your 2016 limit, consider making one of these types of contributions by April 18:

1. Deductible traditional. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k) — or you do but your income doesn’t exceed certain limits — the contribution is fully deductible on your 2016 tax return. Account growth is tax-deferred; distributions are subject to income tax.

2. Roth. The contribution isn’t deductible, but qualified distributions — including growth — are tax-free. Income-based limits, however, may reduce or eliminate your ability to contribute.

3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions you’ll be taxed only on the growth. Alternatively, shortly after contributing, you may be able to convert the account to a Roth IRA with minimal tax liability.

Want to know which option best fits your situation? Contact us.