The tax deductions for contributing to a retirement account can be beneficial when accumulating wealth but not so fun when you are finally required to start making withdrawals based on your age. If you are charitably minded and looking to minimize taxes on your retirement account withdrawals, a strategy of qualified charitable distributions (QCD) may help you pay fewer taxes over your lifetime.
One of my new clients gave north of $100,000 per year to charity, and their previous wirehouse financial advisor didn’t offer tax-planning guidance. This meant before becoming my client, they had been overpaying their taxes and limiting the amount they felt they could afford to donate. This extra $100,000 of realized income increased their Medicare premiums and pushed other income into higher brackets at both the state and federal levels.
Implementing a QCD strategy helped them lower their overall taxes, reduce their Medicare premiums, and get more value from the standard deduction each year. Suppose your financial advisor isn’t giving you valuable guidance on the taxation of your retirement income. In that case, it may be time to search for a financial advisor who better fits your needs.
What Is A Qualified Charitable Distribution?
What rules must you follow to get tax savings from a qualified charitable distribution (QCD)? If you have assets in an IRA, you may be able to exclude your required minimum distributions (RMDs) from your Adjust Gross Income (AGI) when the money is given to a qualified nonprofit.
Following the QCD rules, you can give money from your IRA directly to the charity without receiving it as income. This legal tax-planning strategy allows you to donate the total amount you withdraw from your IRA versus just what is left over after you have paid income taxes due to the federal government and your state.
You can begin using the QCD tax-planning strategy at age 70.5; you don’t have to wait until you are forced to start taking RMDs. And yes, QCDs can count as part of your required minimum distribution each year.
The qualified charitable distribution rule was made permanent by Congress in 2015. With the current gridlock in Congress, I would be surprised if they could repeal this tax-planning strategy, even if they wanted to.
How The QCD Strategy Works In Real Life
1. If you decide to make a QCD, choose a nonprofit and make sure that the charitable organization qualifies as such under IRS rules.
2. Then, let your IRA custodians know your intention to do a QCD. There will likely be a form to sign. If this sounds complicated, don’t worry. Your fiduciary financial planner can help you walk through this process.
3. Once the request has been submitted, your IRA custodian will send a check to the charitable organization on your behalf.
4. Make sure you let your tax preparer know you did a QCD to ensure you get all the tax benefits.
All QCDs must be made directly from your IRA. You will not get these specific tax benefits if the funds are sent to you first and then you donate to the nonprofit.
Assets Eligible For A QCD Distribution
All assets within your IRA are eligible to be distributed via QCDs. However, the IRS does cap the amount you can donate annually via QCD at $100,000. Anything over this amount could still be deductible if taken as an itemized tax deduction.
Technically, QCDs do not give you more tax deductions when you file your taxes. But, they reduce your AGI, often providing more tax savings.
Exceptions To Assets Eligible For QCD
Nondeductible contributions are not eligible to be used for QCD distribution. The good news is that they are already considered a tax-free return of basis, so you won’t owe taxes when you withdraw these funds.
Also, for married couples, you must take one QCD to cover the individual RMDs from each spouse. You can’t just take on a large QCD from one spouse to attempt to cover the aggregate household RMDs for the year.
The AGI Tax Advantages From Qualified Charitable Distributions
The QCD allows you to reduce your AGI through a charitable donation without having to itemize deductions. Individual taxpayers may deduct qualified charitable contributions of up to 100% of their AGI, and corporations may deduct qualified contributions of up to 25% of their taxable income. Donations must be made in cash, and the charitable organization must be a qualifying organization.
Because your AGI is used to determine your taxable income, having a lower AGI can help you to stay in lower tax brackets, reduce or eliminate the taxes due on your Social Security benefits or other income, and remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income driving up your AGI and then taking a itemized deduction for your charitable donations.
The age requirement for taking RMDs was recently raised to 73 from 72 as of Jan. 1, 2023. This applies to withdrawals from traditional IRAs, 401(k) accounts, and SEP-IRAs. There are no RMDs required for Roth IRAs.
Who Should Use The QCD Tax Strategy?
Will you benefit from making a QCD? Ultimately, it will depend on your specific situation. Using a QCD makes the most sense if:
- You don’t need the RMD money right now.
- Not taking a QCD would put you into a higher tax bracket or make other income taxable.
- You want to minimize your RMD amounts in the future.
- You were planning to make a charitable donation anyway.
- You donate to charity but don’t always itemize your tax deductions.
There are scenarios where an RMD may not be the best asset to donate. The example I see most is for people with highly appreciated stocks not held in a retirement account. You can donate highly appreciated stocks directly to a charity and avoid paying capital gains taxes. The tax deduction will be based on the current value of the stocks rather than what you paid.
When Can I Make A QCD From (IRA)?
You can make a QCD from your IRA once you reach age 70.5.
If you are over age 70.5 and plan to give money to charity each year, it behooves you to consider making a QCD. The tax savings may allow you to make an even larger donation or perhaps have a little more retirement income left over for you to enjoy.
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