You donate to your favorite charity each year because it makes you feel good to support a cause that means something to you. The tax benefits received for your philanthropy are a bonus. If you are over 70.5, however, you can support your favorite charity, while increasing the tax savings beyond the charitable deduction by using a Qualified Charitable Distribution.
In a nutshell, a Qualified Charitable Distribution (QCD) is when funds are sent from your qualified retirement account directly to your favorite charity and even though this is a distribution, it is not taxable to you. It is a surprisingly simple strategy that can have some significant tax benefits during your retirement years
70.5 is the magic number.
There are, shockingly, few rules when it comes to the Qualified Charitable Distribution. They are specific, though.
- You must be at least 70.5 to use the QCD
- The payment must be a direct transfer from your retirement account to a public charity, not private foundations or donor-advised funds. It cannot go to you first, and then you write a check to the charity.
- The maximum amount that can qualify for a QCD is $100,000 per year and applies to the sum of QCDs in a calendar year. This is a per-person rule, so your spouse can make a $100,000 QCD from their accounts as well.
- A QCD can only occur in the following accounts
- Traditional IRAs
- Inherited IRAs
- SEP IRAs/SIMPLE IRAs if they are no longer receiving ongoing employer contributions
QCDs can ease the pain of the dreaded RMDs (No it’s not a medical condition)
The government allows you defer taxes in your retirement accounts for years to encourage retirement savings. Uncle Sam eventually wants to begin collecting his tax dollars. That’s when you get a chronic condition known as the Required Minimum Distributions (RMDs) at age 72.
Even if you don’t have a financial need, you have no choice, hence the “R” for required, in RMD. These distributions are taxed as income, and if your qualified retirement accounts are substantial, this could severely impact your tax liability. That is not something you want to deal with in retirement.
There is one note of warning. The passing of the SECURE Act, which allows for traditional IRA contributions as long as you has compensation has thrown possible wrench in the plan. If you are 70.5+ and make any deductible IRA contributions, the amount of QCD that can be excluded from income is reduced by the aggregate of allowed deductions after the taxpayer has reached age 701⁄2. In other words deductible IRA contributions made after age 701⁄2 cannot be used as QCDs. Here is an example.
If you are 71 in May of 2022, still working, and contributes $7,000 (deductible) to an IRA. For 20232, let’s assume your RMD from your IRA is $15,000 and has the entire $15,000 sent directly to a qualifying charity by the IRA trustee. The entire $15,000 will not be treated as a QCD despite following the QCD rules. You have $7,000 in post-701⁄2 deductible IRA contributions. Therefore you will only be able to exclude $8,000 from income as a QCD ($15,000 – $7,000). You will have a taxable IRA distribution and a deductible charitable contribution of $7,000, if you itemize.
That may be a lot to wrap your head around. The bottom line – if you want to contribute, and deduct, contributions to a Traditional IRA after 70.5 AND you want to make QCDs sometime in the future, additional planning is required.
Qualified charitable distributions can help your favorite charity and your bottom line.
The beauty of the QCD is that you can reduce or avoid the taxes on those RMDs by transferring your distribution directly from your retirement account to a qualified charity beginning when you reach 72. You can get a head start and begin QCD’s, a year and a half before RMD’s. Once you reach 72, a QCD has the double benefit of being a tax-free distribution AND counting as an RMD. That’s a win-win.
That elimination/reduction of taxable income by using QCDs goes much deeper than just the noticeable reduction in your income tax. There are powerful potential long-term tax benefits that can allow you to keep more of your retirement savings.
1. A reduction in Social Security taxability
OK, honestly the thresholds to keep Social Security tax-free are meager. A QCD could be the difference between having 0%, 50%, or 85% of your Social Security becoming taxable. It’s a narrow range from 0% to 85%, and unfortunately, most of you will fall into the 85% category, but for those who are close to the 0% or 50% range, the QCD could be the difference.
2. Avoidance of the 3.8% Medicare surtax on investment income
RMDs are not subject to the 3.8% Medicare surtax created to help pay for the Affordable Care Act. RMDs can, however, put you over the income limits of $250,000 for couples filing jointly ($200,000 for singles), which would make any investment income you do have subject to the additional 3.8% tax. A QCD may be the only option you have to get under the income limits
3. Prevent higher Medicare premiums
You may not know this, but all retirees do not pay the same amount for Medicare premiums. It is income dependent. If your income is more than $85,000 (individual) or $170,000 (married), you will be assessed Medicare Part B and Part D surcharges. The level of the surcharge depends on your income. Here is a chart for the details (scroll down a bit when you get there).
That is no small chunk of change, month after month, year after year, of paying surcharges. A QCD could be a financial lifesaver if you were able to eliminate higher Medicare premiums. I don’t have enough fingers to add up the potential savings.
4. Get the tax benefit back
Without the QCD, the only way to receive a tax benefit is to take a deduction, and that only works if you’re able to itemize. The Tax Cut and Jobs Act of 2018 made itemizing your taxes much less likely. So if you lack the ability to itemize the QCD can get the tax benefit back.
The simple QCD process
There is a simple 3-step process to complete a QCD.
- Contact the charity to verify their information and where to send the check, and let them know the check will be on its way.
- Complete a distribution form with the info from step 1. It should have a QCD section. No taxes are withheld! The IRA custodian will then mail the check.
- At tax time you report the charitable distribution on the line for IRA distributions. For the taxable amount, enter zero if the full amount was a qualified charitable distribution. Enter “QCD” next to this line. There’s no box on a 1099-R for QCDs for some reason.
A QCD isn’t just for the wealthy. It doesn’t have to be for thousands of dollars; it could be for fifty bucks. It’s not just for one charity but works best for multiple charities. Think about where you donate throughout the year. Heck, look at last year’s tax return (if you itemize) or your checkbook.
If you’re over 72 and follow the steps precisely, you can use a QCD for your usual yearly giving. Your favorite charity can receive your gift, and you can receive the tax benefit.
If you know a generous soul who is approaching or over 70.5, go ahead and share this with one of the buttons below. They’ll thank you for saving them some tax dollars.