A Guide to Qualified Charitable Distributions
Charitable giving is an important component of many Americans’ financial plans. If you’re wondering how to deploy your funds in a tax-efficient manner and support the causes you believe in, a Qualified Charitable Distribution (QCD) could be an option worth considering.
By taking advantage of a QCD, taxpayers can fund a charitable gift of up to $100,000 using their IRA instead of taking a Required Minimum Distribution (RMD). In addition to helping investors advance their charitable initiatives, QCDs entitle donors to income tax deductions that can lower their taxable income for the calendar year in which they’re made.
As with any tax strategy, be sure to consult with a tax professional who can help you incorporate a QCD into your larger financial plan.
The IRS requires taxpayers 73 and older to make regularly-scheduled withdrawals from their tax-deferred accounts in the form of RMDs. Retirees must take RMDs each year thereafter, slowly whittling down their account balances over the course of retirement.
RMDs can cause headaches for retirees because the amount that must be withdrawn has to be calculated on a case-by-case basis and, most importantly, it gets treated as ordinary taxable income. However, you may be able to avoid triggering this tax event by using your distribution as a charitable gift instead of claiming it as income.
An Alternative to RMDs
For investors interested in avoiding these required retirement account withdrawals, either because they don’t need the funds or because they’d benefit more from lowering their taxable income, an alternative route exists.
A QCD allows you to manage your income tax liability by donating your distribution directly to a charitable organization of your choice. Instead of claiming your withdrawal as income, as you would in the case of a typical RMD, your philanthropic gift entitles you to an income tax deduction when it comes time to fill out your tax return.
As long as you’re at least 70½ years old and own an IRA (traditional and inherited plans are acceptable, as are inactive SEP and SIMPLE plans), you may select a qualifying charitable organization to direct your funds to. Once you’ve determined the size of your gift and specified a recipient, your IRA custodian will either cut a check to the charity on your behalf or provide you with a check to deliver to the charity yourself. You’ll then account for this gift on your annual tax return, earning yourself an income tax deduction.
While the process is simple, making QCDs may not make sense for every investor. Here are some important rules and regulations that bear consideration.
- The donor must be 70½ years or older to make a QCD, though taxpayers are not responsible for taking RMDs until they turn 73.
- The recipient must be a qualifying charitable organization, as specified by the IRS. Donor-advised funds (DAFs), private foundations, and ancillary or supporting organizations generally do not qualify.
- For it to be treated as part of an RMD, QCDs must be made prior to December 31 of the relevant tax year. Since these distributions only apply to the year in which they’re taken, tax benefits cannot be carried forward into future years.
- To qualify as a QCD, funds must be distributed from the IRA to the recipient. Funds distributed directly to the IRA owner and then donated to charity will not qualify.
- Currently, the maximum amount that can be gifted as part of a QCD is $100,000 per year, per individual. For married couples filing jointly, the annual limit is $200,000.
- For donors who itemize their giving on their taxes, QCDs do not count against the annual limit for charitable tax deductions prescribed by the IRS, which is generally between 20 and 60 percent of the donor’s gross income.
- A QCD can account for the entirety of an RMD or just a portion of it. In the latter case, the taxpayer must still withdraw the difference from their account as an RMD. To illustrate, if your RMD is $5,000 and you only gift $3,000 to charity, you’d still be responsible for withdrawing the remaining $2,000 and paying taxes on it.
Potential Benefits of Making QCDs
QCDs can be helpful tools for donors looking to advance their charitable initiatives while also earning favorable tax treatment. This could make them an appealing strategy for high earners, in particular. Here are some of the potential benefits.
- Alternative to RMDs: Provides another use for your RMDs if you don’t need the cash to live on and would be subject to a higher tax burden if you claimed the distribution as income.
- Save on Future RMDs: Draws down the total balance of your IRA, which potentially reduces the size of your future RMDs and lowers the amount you’re ultimately forced to pay in income taxes over the life of the account. Remember that any amount donated in excess of your RMD cannot be applied to future RMDs.
- Give More, Deduct More: Enables you to deduct a larger portion of your income than you might be able to otherwise. As stated previously, QCDs don’t count against the total value of charitable deductions you can claim on your tax return each year. This means that by making a QCD, donors can increase the amount they commit to charity each year beyond the annual deductible limit. More giving can translate into a higher tax deduction and ultimately a lower total taxable income, particularly if your giving knocks you down to a lower income tax bracket.
- Philanthropic Autonomy: Allows you to make a meaningful contribution to the charitable organization of your choice. Instead of filtering your contribution through a donor-advised fund (DAF) or private foundation, you can gift a lump sum directly to a qualified organization you’ve identified.
Interested in Making a QCD?If you own an IRA and are searching for an alternative to your next RMD, a QCD may be an opportunity to lower your tax liability for the year while also making a direct contribution to a charitable organization of your choice. If this describes you, think about reaching out to a tax professional before taking action on your own.
However, for philanthropists younger than 70½ years old or those interested in making charitable gifts in excess of $100,000 annually, a QCD may not be the most appropriate method of facilitating your charitable goals. Additionally, if you are hoping to spread out your tax burden over a handful of years as opposed to making a lump sum contribution, you may prefer another strategy.
If you are considering making a significant charitable gift, we can help you assess your options and identify the right course of action for you. Schedule an introductory meeting here.