Q: We are thinking about tax planning before the end of the year. For the past couple of years, our tax preparer mentioned making “Qualified Charitable Donations” from our IRA, but we feel too uninformed. Please explain.

A: Your tax preparer is giving you good advice. Making qualified charitable donations (QCDs, for short) directly out of your IRA will both lower your tax bill and help your favorite charities. It’s a win-win for everyone but Uncle Sam. Actually, I suppose that makes it a win-win-win!

To explain why donations from your IRA are smart, we have to go back to the Trump-era tax cuts. Starting in 2018, the standard deduction essentially doubled in size. Suddenly about 9 out of 10 taxpayers no longer itemize their tax deductions. Given this, the vast majority of people also no longer enjoy a tax break when making charitable donations.

The doubling of the standard deduction really left only one other avenue to enjoy a tax deduction for your charitable giving. For some, I should say. For those over the oddball age of 70.5, you are allowed to donate directly from your IRA and it won’t be counted as taxable income as it normally would be coming out of a (never been taxed) IRA.

Better yet, once you reach the age of 73, your IRA donations will count as part of your required minimum distribution (RMD.) Theoretically, you could give away all of your RMD to charity (up to a current annual limit of $100,000) and not have to pay a dime of taxes on any of it.  

Q: I am hearing mixed signals about bonds. On one hand, bonds have been a drag in my portfolio over the last two years. On the other hand, now their current yield is looking really nice. Which side of the coin should I focus on?

A: Bonds keep coming back up, no pun intended. Normally, bonds should be one of the most boring things in your portfolio. Lately, bonds have been anything but boring.

As I wrote a couple months ago, bonds that were originally issued during the super low interest rate environment are now selling at depressed prices. For long-term bonds, I’d say they are selling at highly-depressed levels. Naturally, those old bonds are less desirable since they only pay paltry levels of interest until they mature. So, price is the great equalizer that puts those old bonds on a level playing field with newly issued bonds that come with much higher rates.

My advice is to fight against your tendency to look backward. With the 10-year US Treasury selling at yields near 5%, a level not seen in about 16 years or so, bonds appear quite attractive and should be a healthy segment of any balanced portfolio.  

Q: Our son and his wife are looking to buy a home in Traverse City. Our advice to them is difficult to give and certainly for them to receive. Perhaps that’s due to our long memories of the reasonable home prices of yesteryear! Any advice you can give them and us would be appreciated.

A:  Giving advice to others is often hard, especially when it’s unsolicited! But, as a parent, I know it’s nearly impossible to remain silent. Hopefully, your son and daughter-in-law will take any advice you offer as heartfelt. Acknowledging that you may have some preconceived notions of what you see as value will demonstrate your sincerity.

Younger adults face a totally different environment than the generations of homeowners before them. With 30-year, fixed rate mortgage rates skyrocketing from a bit above 3% to now over 8% in just two years time, buying an identically priced home results in a 70% higher monthly payment. Adding insult to injury, since just before Covid hit, home prices have jumped over 40% nationally.

Taking these two facts in combination – higher rates along with higher prices – homebuyers today face more than a doubling of their housing costs compared to just a few years ago. This indirectly feeds into higher rental rates for those who are unable to even consider buying a home. There really is no way to escape the situation as everyone, in the end, needs a roof over their head. And, honestly, there is no way for society to ignore the situation, either. But, solutions are hard to come by.

I’m afraid my advice will feel awfully basic.

Before buying a home, your son and daughter-in-law need to be confident that their income is very secure. Their higher mortgage obligation will no doubt place a strain on the rest of their budget. The greater share of their income dedicated to their housing cost will impact their ability to spend on other things like travel, entertainment and eating out, let alone funding their other necessities.

While living close to both work and play is really attractive, considering a home outside of town might afford them the money to actually enjoy the amenities of our area. This is a real trade-off.  But, you should know that this advice might smack of hypocrisy coming from someone who was lucky enough to buy a home in town years ago before the surge in prices.

Our area is wonderful in so many ways, but it’s obvious that the access to this wonder is not spread evenly among us. While I imagine you have full perspective, it’s always important to recognize that your son’s challenge in deciding where and when to buy a home in our area is a truly fortunate problem to have. It might be a lot tougher for many others.

Q: Back in 2013, I inherited my younger brother’s IRA. He was 73 when he died. I was 6 years older than him. Since 2014, as advised by my bank, I’ve taken out my required minimum distributions (RMD) based on my life expectancy, not his. However, this year my bank has calculated my RMD based on my brother’s life expectancy, not mine. Can you clear this up for me? 

A: You’ve presented a rather interesting case. The quick answer is your bank is now finally giving you correct advice regarding your required minimum distribution or RMD. I emphasize the word, finally, because for the past 9 calendar years you’ve distributed and paid tax on more than was required. This is both unfortunate and irreversible. 

To start, the rules did change in 2020 for many IRA beneficiaries. Prior to 2020, non-spouse IRA beneficiaries were allowed to “stretch” their RMDs over their life expectancy. After 2020, most non-spouse IRA beneficiaries are now forced to distribute their inherited IRA balance within 10 years. 

Since your brother died in 2013, you get to keep using the old “stretch” rules. At first blush, the bank would appear correct in using your life expectancy to calculate your RMD. However, there was an added wrinkle that your bank overlooked. Given that your brother had already begun taking his required minimum distributions each year, your subsequent Inherited IRA distributions should have been based on his younger age, not yours. 

Let me demonstrate the impact. Since he was 73 years old at the time of his death, his life expectancy using the IRS’s life expectancy table (which was updated in 2021) was 16.4 years. The rule states that for all subsequent years, you need to subtract 1 year from his original life expectancy and then divide each year-end account balance by that adjusted life expectancy figure. 

For 2014, your first divisor should have been 15.4 or one less than his original life expectancy of 16.4. Now, fast forward all the way to 2023. Your RMD this year should be calculated as your 2022 year-end account balance divided by 6.4, which is now ten less than his original life expectancy. Yes, this is a hefty 16% of your account, but it’s much better than being forced to distribute a truly massive 35% of the account using your age. In the end, I’m very glad the bank is now getting it right.

For interested readers, you can review the Inherited IRA distribution rules on page 10 of the IRS Publication 590-B or by visiting www.FrontStreet.com/InheritedIRA. This link will automatically forward you to an IRS page that does a good job of explaining the rule.

Q: I was talking to a friend the other day. She told me I am allowed to rollover some of my IRA to my Health Savings Account. Is this really allowed? Please explain.

A: Your friend is absolutely right. But, as is the case with most things in the world of money and taxes, there are some key things to understand and a few rules to follow.

If you are eligible, once in your lifetime you are allowed to do a rollover of part of your IRA into a Health Savings Account, most often referred to as an HSA. Note the three phrases, if you are eligible, once in your lifetime and part of your IRA.

To be able to do an IRA-to-HSA rollover, you have to be enrolled in an HSA-eligible health plan during that tax year. HSA-eligible plans are also referred to as  high-deductible health plans. To prevent wasting your time, be sure to investigate your health plan first to see if you can even consider a rollover.

If you do qualify, make sure you’re pretty confident you’ll be enrolled in an HSA-eligible health plan for a full 12 months following the date of your IRA-to-HSA rollover. If you fail this one-year eligibility test, you’ll end up having to pay income tax on the IRA distribution. Adding insult to injury, if this happens and you are under age 59.5, you’ll even have to pay a 10% tax penalty for taking an early withdrawal.

Now, once in your lifetime you are only allowed to rollover up to the maximum HSA contribution amount for the year. In 2023, a single person can contribute up to $3,850 to an HSA and a married couple can contribute up to $7,750. If you are over age 55, you can tack on another $1,000. And, if you want to rollover the maximum amount allowed, just know that any other contributions made to your HSA during that same year need to be factored in. Please note, if you are married, you and your spouse can each do an IRA-to-HSA rollover.

Why is this IRA-to-HSA move such a good thing? Well, given that your IRA is most likely funded with pre-tax money, eventually you’ll have to pay income taxes on your IRA money. That was the trade you made when you took the tax deduction on your taxes. With this one-time, limited size IRA-to-HSA move, you are able to transform money that enjoyed a tax break into money that will never be taxed. Of course, that’s only true if you end up having health care expenses. No worries, that’s a bet I’m sure we all can make!

Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com