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Public Good IRA Rollover

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Case:
Ralph Emerson, 68, is a recently retired doctor. Dr. Emerson has accumulated a very large IRA. After 35 years of contributions and tax-free growth, Dr. Emerson's IRA balance has reached $5 million. In addition to his IRA, he owns a $1.5 million home and has additional property worth approximately $500,000. Dr. Emerson withdraws about $150,000 a year, or 3% of his IRA plan balance, for living expenses.

Dr. Emerson has long supported charitable causes and wants to establish a substantial endowment in his name. He discussed the creation of a supporting organization with his advisor, Ted Wright. After reviewing the plan, Dr. Emerson wanted to fund a $1 million named endowment at his death.

Question:
Dr. Emerson asked if he could immediately create a $1 million charitable gift annuity from his IRA, which would fund his gift at his death. What are the tax consequences for implementing this plan? Would the result be different under the Public Good IRA Rollover proposed legislation? How so?

Answer:
Under current law, an IRA or other qualified retirement plan may not be transferred directly to a CRT/CGA. As a result, an IRA owner must first take a distribution from the plan and then make the transfer. Unfortunately, this scenario causes the IRA owner to have taxable income equal in most cases to the amount of the IRA distribution.

Specifically, if Dr. Emerson funds his CGA with $1 million from his IRA, then he will have $1 million of ordinary income to report. With a 7% CGA, Dr. Emerson will not receive a $1 million deduction but instead a $350,000 charitable income tax deduction, subject to the 50% of AGI limitation for cash gifts. This plan, therefore, results in about $650,000 in taxable income, which may produce a tax liability over $260,000 after taking federal and state income taxes into account.

If the Public Good IRA Rollover bill (S. 819) passes, the CGA plan is dramatically more desirable. First, the transfer of $1 million to Dr. Emerson's CGA would produce no charitable deduction under the proposed law. However, and more importantly, it would not trigger $1 million of taxable income to Dr. Emerson. Thus, with the Public Good IRA Rollover proposed legislation, it cost Dr. Emerson nothing (from a tax standpoint) to transfer his assets from his IRA to his CGA! Without the Public Good IRA Rollover legislation, the net tax result was about $650,000 of taxable income to Dr. Emerson just for moving assets from his IRA to his CGA.

At the age of 68, the annuity payments will be $140,000 per year ($2,000,000 x 7%). Because an IRA is generally all ordinary income funded with pretax dollars, Dr. Emerson has no basis in his IRA. Accordingly, the charitable gift annuity will produce no tax-free income or capital gain payouts. Therefore, the annuity payments each year will be all ordinary income, similar to a distribution from an IRA. Unlike an IRA however, the annuity payments will continue for Dr. Emerson's lifetime irrespective of the plan balance and will not be subject to the minimum required distribution rules.

Clearly, the Public Good IRA Rollover has wonderful tax benefits for donors and will initiate more gifts to charity.

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