MSU Extension: Should Your IRA Beneficiary be a Non-Profit or Family Members?

This is one in a series of articles focusing on estate and legacy planning. Authors are Kaleena Miller, Madison-Jefferson County Extension Agent, kaleena.miller1@montana.edu and Marsha Goetting, MSU Extension Family Economics Specialist, marsha.goetting@montana.edu.

Are you one of those who have had a traditional IRA for years and years, perhaps since the creation of IRAs in 1976? At the time, you may have designated your spouse and/or your children as the beneficiaries. This made sense because your spouse could roll the IRA into their IRA. And your children could withdraw the amounts based on their life expectancy, hence the name of the “stretch IRA.” For example, a 30-year-old could withdraw the minimum distribution from the inherited IRA for 55 years. Because Secure Act 2 changed the rules about IRA withdrawals, you may want to reconsider your initial plan.

The good news is the spouse can still inherit the IRA and make withdrawals based on their life expectancy. But now, if you name your children, they must use a new 10-year rule to deplete the IRA account. So, instead of being able to stretch the inherited IRA withdrawals over their lifetime, the beneficiary must draw the account by the end of the 10th year following the deceased’s passing.

The amount they withdraw from an inherited traditional IRA is subject to ordinary income taxes at the state and federal levels. Fidelity, an investment company, reported that the average IRA balance at the end of December 2023 was $116,600. That means your child would need to withdraw at least $11,660 the first year and add the income on top of their earnings. That could possibly put them in a higher income tax bracket at both the state and federal levels.

Since charities and non-profits are exempt from income tax, they can receive the entire IRA and avoid payment of any state or federal income tax. For example, if you left $116,600 to the Montana 4-H Foundation, the foundation would receive the full $116,600. Then, you can leave other assets to your children, who receive a step up on the basis of the value. The step-up in basis is available to assets of a deceased person because of the owner’s death. For example, a deceased person left stocks with a basis of $100. At the date of death, the stocks were worth $116,600 and sold for that amount. There is no capital gain and thus no state or federal income taxes on the stock sale.

Another idea is to use the IRA to make an IRA charitable rollover gift as a qualified charitable distribution (QCD). An added benefit for IRA owners who are age 70½ or older is that a QCD may fulfill part or all the required minimum distribution (RMD) for 2024.

A traditional IRA owner first needs to contact the IRA trustee to start the process for a QCD. While distributions from a traditional IRA are normally taxable, the QCD payouts will be tax-free if they are paid directly to a qualified nonprofit, such as the Montana 4-H Foundation.

An electronic payment or a check made out to the IRA owner does not qualify as a QCD. The QDC 2024 limit is $105,000. If spouses are both over age 70½ and have separate IRA accounts, then the $105,000 per person limit may allow a couple to distribute up to $210,000 from their traditional IRA per year to charity. Because the QCDs are not taxable, there will be no charitable deduction but that’s fine because you don’t have to report the withdrawal as income.

Your QCD must be reported on your 2024 federal income tax return. You can expect to receive an IRS Form 1099-R from your IRA trustee, with the traditional IRA distribution in Box 1. You must report the IRA distribution on Line 4 of IRS Form 1040. You will enter the total amount of the IRA distribution on line 4a. If the full amount is a QCD, you then enter zero on line 4b. If part of the distribution is a QCD, the taxable part is normally entered on line 4b. You must enter “QCD” next to line 4. If you have entered zero on line 4b, the entire QCD will not be taxable.

While your QCD is not deductible as a charitable contribution, you must obtain a written QCD acknowledgment from the nonprofit prior to filing your return. This acknowledgment should say the date and amount of the QCD and say that the donor has received “no goods or services in exchange for the gift.” You should keep the acknowledgment with your other 2024 tax records.

More information is available from the IRS publication 590-B distributions from Individual retirement accounts. https://www.irs.gov/publications/p590b.