The first is a rule that allows individuals who are over 70½ to make a charitable contribution from their IRA to a charitable organization. The main stipulation is that the money contributed is sent directly to the charitable organization and is not routed through the individual.
The benefit the contributor receives is that the withdrawal, which is normally part of their annual income, is no longer counted as such. A person can make this type of contribution up to $100,000. The rule, as it stands now, is only available in 2007.
Who would want to use this?
Many people who are over 70½ no longer have mortgage payments. If they are healthy and do not have medical expenses that are more than 7.5 percent of their AGI, they have few itemize deductions. Therefore, the incentive to give to charitable organizations from a tax perspective is negligible.
For example, under the old rule, if you made a withdrawal from your IRA to give to a charitable organization, the gift you make would increase your income with no offsetting itemized deduction. The new rule allows you to give to your charity, not increase your taxable income, and take the standard deduction.
A person might also be concerned about Social Security payments. If a person can keep their income low, the Social Security payments are also taxed at low levels. As your income increases, taxes on Social Security payments increase. The maximum rate at which Social Security is taxed is 85 percent. By transferring a portion of an IRA directly to a charity, a person might be able to avoid increasing their income. The gift qualifies as a required distribution and could save substantial taxes on Social Security.
Transferring from a traditional ira to a Roth ira
This past Spring, Congress passed a law that starting in 2010, regardless of income, an individual can transfer their traditional IRA to a Roth IRA. What is great about this is that there were restrictions placed on how much income you could make in order to transfer money.
Currently, if you make over $100,000 a year, whether single or married, you cannot transfer money from a traditional IRA to a Roth. In 2010, that rule goes away.
So you might be saying to yourself, "Well that's great but I have to wait until 2010 to do something different than I'm doing now?" Not really!
Following is a strategy for a person with a qualifying income. The strategy can start this year in anticipation of the change coming in 2010.
As mentioned above, contribution to a traditional IRA is not prohibited, even at higher income levels.
Let's say you're a vending business owner with an income that did not allow you to deduct your contributions to a traditional IRA. However, there is an opportunity with the rule change. You make contributions to an IRA in 2006 and 2007. Each year, you will be able to contribute $4,000. In 2008, the maximum contribution increases to $5,000. So in 2008, 2009 and 2010, you put away another $15,000, for a total $23,000.
Let's say that at the end of 2010 the value of account is $30,000. At that point, you roll the traditional IRA over to a Roth IRA. You'll only owe taxes on the $7,000 in earnings. From that point forward, all earnings will be growing tax free. It's a simple strategy, but one that could pay off handsomely if employed early enough.
Although the future financial burden that most of us will face is greater than recent past generations, there still are opportunities to prepare if one has discipline. There are many other strategies that can be used for other kinds of future needs. The rules change frequently. It's an exciting and daunting challenge all the same. Be vigilant in learning about what choices you have available to you.