Most people are aware that, under the current tax laws, an IRA owner who has reached age 70½ can make a direct donation of $100,000 from their account to a charity without having to report the contribution as income. This is often referred to as a “qualified charitable distribution,” or “QCD.”

This is a great way for people over 70 to both give money to charity and save on taxes. The taxpayer is essentially giving pretax money to a worthy cause, which in effect creates a dollar-for-dollar income tax deduction they’d otherwise not receive. It’s especially helpful under the current tax regime. The federal standard deduction for those over 70, married but filing jointly, currently stands at over $30,000 (including the additional amount for seniors). Also, there are limits on people’s state and local income tax deductions (which stop at $10,000). Because of the high standard deduction and the state and local limits, and the fact that most people 70 and over are unlikely to have much in the way of deductible interest charges, all or much of a person’s annual donations to charity are currently not tax deductible. The QCD allows taxpayers to circumvent this problem and get deductions in a different way, so the strategy is a win for these clients.

What about taxpayers who aren’t that old? Is there a way for them to donate pretax IRA or 401(k) moneys to charity? If not, these deduction hurdles will likely mean they’ll be doing their charitable giving with after-tax dollars.  

People seeking innovative tax strategies face another problem: the SECURE Act, passed by Congress in 2019. This legislation created a double whammy for retirement plan beneficiaries. If they inherit money from the IRA or 401(k) plans of deceased parents or other relatives, they not only have to add those proceeds to their taxable income—but squeeze it all into a tight 10-year period. That money is likely to flow into their accounts during their peak earning years, which means their taxes will rise much more than they would if they were retired. The double whammy is this: The higher income taxes must be paid within 10 years of the account holder’s death, rather than deferred over the beneficiary’s lifetime. The combination of these two factors—significantly higher income taxes and the lost time value of the money for the years the beneficiaries survive—can easily mean a total loss of twice as much as what the inheritors would have lost under the law before.

These SECURE Act problems are exacerbated by the tax deduction hurdles, meaning most IRA and 401(k) beneficiaries (especially those with little or no mortgage left on their homes) won’t receive a full federal income tax deduction for what they give each year. Some of the tax deduction problems could be resolved if the deduction limits are restored in 2026 to their past levels (that’s the year the Tax Cuts and Jobs Act might sunset). In that case, taxpayers could again take meaningful charitable deductions. But the SECURE Act problems remain.

One possible way through the unfavorable tax environment is for IRA or 401(k) account owners to create a pool or pools of money, effective at their deaths, that their children can use later for their annual charitable donations. The owners could create a pool of money by designating a donor-advised fund as beneficiary of all or a portion of the retirement account upon their deaths. The idea is that, if the children are going to be making annual charitable donations throughout their lifetimes, the owners can arrange it so the kids don’t end up using largely after-tax funds to make these donations. Instead, they can pull pretax money from the charitable vehicle.

Take Fidelity Charitable’s donor-advised fund, which allows an IRA owner to set up multiple giving accounts for multiple heirs. Each inheritor can have his or her own account under this program, Fidelity says.

To see how this strategy would work, let’s imagine an IRA owner. He estimates that each of his children, who are in their mid-to-late 50s, will each donate a total of $100,000 or more to charity over the rest of their lives. The owner could give each of them $100,000 directly from his IRA for this purpose at his death. The problem, we now know, is the SECURE Act: After a direct beneficiary payout of $100,000, each of the children may end up owing $40,000 or more in income taxes (including state income taxes). That means they have only $60,000 remaining to give to charity. 

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