Inherited IRA and donor advised funds

[niknak]

I recently inherited an IRA from my grandmother who passed away late last year. It's my understanding that I have to withdraw all of the funds from the IRA within 10 years. Since I don't need the money, I'd like to donate it. But I'd also like the IRA distributions to not negatively affect my taxes. Is it possible to set up a donor advised fund (DAF) and put the distributed money directly in it? How would this affect my taxes?

[secondcor521]

You can have a DAF, and you can put the distributed money into it.

However, if the IRA is a traditional IRA, then any distributions are taxable income to you regardless of what you do with them.

To minimize the tax bite, consider spreading the withdrawals evenly over the 10 year period, taking into consideration what you expect your taxable income situation to look like over that period of time.

Sorry for your loss.

[terran]

To minimize the tax bite, consider spreading the withdrawals evenly over the 10 year period, taking into consideration what you expect your taxable income situation to look like over that period of time.

Alternatively, if you decide to put some/all of it in a donor advised fund make a withdrawal equal to the full amount you want to contribute to the DAF in a single year. That way you only have to overcome the standard deduction with itemized deductions that one year instead of over 10 years. There are limits to how much of your income (as a percentage) you can deduct for charitable contributions, so make sure you stay within those.

[MustacheAndaHalf]

From memory, I think DAF can be funded with assets already held long-term.  Meaning if you have ETF, stock or mutual fund shares that are subject to the reduced long-term capital gains tax (LTCG), you can send those assets into a DAF.  You don't sell them, you transfer them - skipping the typical 15% long-term capital gains tax.  Besides not paying LTCG, you also deduct the amount of the donation in that tax year.

I don't think IRAs qualify.  It might be better to donate long-term shares to the DAF, and invest IRA proceeds in something similar.

You get a tax deduction when money/assets go into a DAF.  Once the money is inside the DAF, it no longer has tax implications - because it's no longer your money.  You then direct which charities should receive which amounts at which times.

[SimpleCycle]

You can have a DAF, and you can put the distributed money into it.

However, if the IRA is a traditional IRA, then any distributions are taxable income to you regardless of what you do with them.

To minimize the tax bite, consider spreading the withdrawals evenly over the 10 year period, taking into consideration what you expect your taxable income situation to look like over that period of time.

Sorry for your loss.

It's taxable income, but it can be offset by a charitable tax deduction. Like you make $100k in wage income, you withdraw $50k from the IRA, and you put $50k into a DAF.  The $50k you put in the  DAF is tax deductible, so your "taxable income" is still just $100k (minus deductions and all that).

[secondcor521]

You can have a DAF, and you can put the distributed money into it.

However, if the IRA is a traditional IRA, then any distributions are taxable income to you regardless of what you do with them.

To minimize the tax bite, consider spreading the withdrawals evenly over the 10 year period, taking into consideration what you expect your taxable income situation to look like over that period of time.

Sorry for your loss.

It's taxable income, but it can be offset by a charitable tax deduction. Like you make $100k in wage income, you withdraw $50k from the IRA, and you put $50k into a DAF.  The $50k you put in the  DAF is tax deductible, so your "taxable income" is still just $100k (minus deductions and all that).

True, but it does increase your AGI, which is used for all sorts of tax items, including stimulus payments, ACA subsidies, and FAFSA EFC (soon to be SAI).

There are also percentage limits on how of a person's income (defined as AGI I'm fairly certain) can be donated to charity, as @terran alludes to above.  Although I'll also mention that those limits were temporarily raised in some of the coronavirus bills last year, so OP may, if they're charitably inclined, look into doing their DAF stuff in 2021 for that reason.

[seattlecyclone]

I recently inherited an IRA from my grandmother who passed away late last year. It's my understanding that I have to withdraw all of the funds from the IRA within 10 years. Since I don't need the money, I'd like to donate it. But I'd also like the IRA distributions to not negatively affect my taxes. Is it possible to set up a donor advised fund (DAF) and put the distributed money directly in it?

Sure.

How would this affect my taxes?

At a high level, the IRA withdrawal will increase your AGI by the amount of the withdrawal, and the DAF contribution can be an itemized deduction in the amount of the contribution. If you itemize already, this IRA withdrawal and DAF contribution will have no net effect on your taxable income, and therefore no effect on your basic tax before credits.

If you don't itemize already, your taxable income will increase by the difference between your standard deduction and whatever itemized deductions you could have claimed in the absence of the donation. For example, suppose you're married, have $10k of state/local tax you could deduct, $5k of mortgage interest, and no charitable contributions before your grandmother passed away. $15k is less than the standard deduction ($25,100 in 2021), so you haven't been itemizing. This year, suppose you withdraw $30k from your inherited IRA and donate it to charity. Now you have $45k worth of things you can deduct, so you itemize this year. However your itemized deductions are only $19,900 higher than the standard deduction. The rest of your $30k IRA withdrawal ($10,100) will increase your taxable income compared to last year.

That's how it works for your basic tax calculation. As @secondcor521 noted, there are various tax credits that are based on your AGI rather than your taxable income. You'll need to see which of these (if any) you qualify for, at what AGI limits that would change, and try to keep your AGI below those limits in order to minimize the effect of this IRA on your taxes.

I will echo the recommendation to look into transferring appreciated stock into the DAF instead of cash. You get to deduct the current value of the shares, and you can use the cash from the IRA to buy that same stock right back again at current prices. It's a little more convoluted than just donating cash, but you get to reset your taxable cost basis this way.

Note that the limit for deducting stock donations is 30% of your AGI, and the limit for deducting cash donations is 60% of your AGI. If you donate some cash and some stock, they can only add up to 50% of AGI in total. Any donation above these limits can carry forward to be used as an itemized donation next year.

It's true that the limit on deducting charitable contributions was increased for 2020 and 2021. The higher limit only applies to direct cash contributions to operating charities. DAF donations don't count.

[niknak]

Thanks for the informative replies all! I'll definitely refer to your recommendations when I get the ball rolling this year.