Giving from a Traditional Individual Retirement Account (IRA) has been around for several years, but still is not a widely known option. If you are charitably inclined, it can potentially benefit you and your favorite charity(ies).
This post will examine how this option works, when it can be appropriate to use and some of the potential pitfalls to avoid. Though this topic can be a bit complex, I hope it will give you some thoughts to consider.
The technical term of giving from your IRA is called a Qualified Charitable Distribution or QCD. It has been around since 2006, but was initially only a temporary option that was extended by Congress several times. It became a permanent option in 2016.
The IRS states that a “QCD is generally a nontaxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions.” In plain English, you can direct the organization who holds your IRA account to send money directly from your IRA to a qualified charity (the check is made out to the charity) of your choice.
You are not able to deduct the gift from your taxes, but you also don’t pay any tax on the distribution.
Before we get into the details, let’s first look at…
Required Minimum Distributions
When you turn 72 the IRS requires you to start withdrawing a minimum amount of money out of your Traditional retirement accounts (Traditional IRA, 401(k), 403(b), SEP & SIMPLE IRA’s) each year, whether you need it or not. This is called a Required Minimum Distribution (RMD).
RMD’s exist because Uncle Sam wants the tax money that has been deferred for years.
When you contributed to your Traditional retirement accounts, your contributions were deducted from your taxable income when they were made. For most people, that means none of the money has been taxed. When you withdraw money out of Traditional retirement accounts, 100% of the distribution is taxed at your ordinary income tax rate.
You can always withdraw more than your RMD, but you must take at least the RMD every year.
If you do not take your full RMD out by the end of the calendar year, the IRS will take 50% of the amount you should have taken as a penalty, and send the remaining 50% to you. Therefore, it is really important to ensure your RMD is taken every year.
Your RMD is calculated every year for each Traditional retirement account you own, and is normally calculated by your investment provider. They use the December 31st value of your account from the prior year and divide it by a factor that the IRS periodically updates.
If you have multiple retirement accounts, you can withdraw your RMD from each individual account as calculated, or withdraw your total RMD from one account. The key is, the total RMD must be distributed each year by December 31st.
How Are QCD’s Beneficial?
There are times when people don’t need the money from their RMD and prefer to give it to charity. Sometimes people are trying to avoid getting bumped up into the next tax bracket (by having more income from an RMD). This is where the QCD can be helpful.
When you use a QCD you do not deduct the amount of the charitable gift on your taxes. Rather, your RMD (which is taxable income) can be offset by the QCD contribution.
For example, if your RMD is $10,000 for the year and you direct your IRA Trustee to send $10,000 via a QCD to charity, your taxable income has not changed at all. However, if your RMD is $10,000 and you give $5,000 via a QCD to charity, your taxable income will increase by $5,000.
You can donate some, all or none of your RMD to charity. This decision is made each year, and does not carry over to future years.
A QCD can be a helpful tool for those who are charitably inclined.
QCD Key Details
There are several key points to be aware of:
- It is generally used for Traditional IRA accounts (not SEP or SIMPLE IRAs), and does not apply to your 401(k)/403(b). You could use it for a Roth IRA, but since distributions from that account aren’t taxable, it is not as beneficial (tax wise)
- You must be 70 ½ or older
- Money must be sent directly to a 501(c)3 charity. The funds cannot go to a Donor Advised Fund (DAF) or a private foundation
- Checks must be cashed by the charity before 12/31 of the year given
- It is limited to the amount that would be taxed as ordinary income (ie if you have non-deductible contributions, special rules apply)
- The maximum amount that qualifies as a QCD is $100,000 per person across all your accounts. If your RMD is greater than $100,000, the difference will be taxed as ordinary income
- Though a QCD can have a Federal tax benefit, you will want to check with your State to see if the QCD is taxable or not. In PA, IRA distributions are not taxable, so the QCD does not impact PA state taxes
What Are The Advantages of QCD’s?
There are a few ways people can benefit from a QCD:
1. Lowers Taxable Income
As your QCD replaces the taxable income you would normally receive from your RMD, it lowers your taxable income from your IRA. This is the most tax efficient way to give from your IRA (as opposed to taking your RMD and then giving it to charity).
2. Potentially Receive A Tax Benefit For Giving
The standard deduction is the amount the IRS allows any tax filer to deduct off their Adjusted Gross Income (AGI). The amount of the deduction depends on their filing status and age. If you have qualified deductions that exceed the standard deduction, the IRS allows you to use them instead of the standard deduction. This is called itemizing your deductions.
In 2017 the standard deduction increased greatly, leaving only about 15% of filers itemizing their deductions. If you are not able to itemize, then your charitable giving is not tax deductible.
If you do not itemize, utilizing the QCD lets you receive some benefit (in lower taxable income) through your charitable giving.
3. May Help With Medicare Premiums
Medicare premiums are calculated based off your income in retirement. Once your Modified Adjusted Gross Income (MAGI) passes certain thresholds (above $88k for a single filer and above $176k for a joint filer in 2021), you pay an additional amount for your Medicare Part B & D premiums. This is called the Income Related Monthly Adjustment Amount (IRMAA), and it is based on your MAGI from 2 years ago.
For example, if the MAGI calculated from your 2020 tax return is greater than the thresholds, then your Medicare Part B & D premium will be assessed the IRMAA (an extra charge) starting in 2022. You can read more about Part B and Part D charges here.
A QCD can be used to reduce your taxable income and may keep you either below the initial threshold, or from potentially moving into a higher IRMAA bracket.
4. Benefits Charity
Most of all, it is a great way to benefit charity(ies). The QCD is one of the few ways to benefit some taxpayers and their charities, potentially making a meaningful difference for both.
Unfortunately, there is not a standard QCD process that is used throughout the industry. It is really important to contact your IRA Trustee to understand how they handle this. Here are some of the points to discuss:
- Distribution Requests – Some IRA Trustees will require paperwork per transaction or you can set up a recurring distribution, while others will provide a checkbook for a client to write checks directly from the account.
- Gift Designations – If you want the funds to support a specific project at the charity, some IRA Trustees will include that on the memo line of the check, but others will not. In that case you will need to reach out to the charity directly and let them know your request. They are not required to honor it, but most will.
- Gift Receipts – Though the gift is not tax deductible, you want to retain proof that it is a gift. Some IRA Trustees can include a note on the check requesting the charity send you a QCD receipt you can keep with your files (if you are a new donor to the charity, they won’t have your address). Other Trustees do not, and you may need to request copies of the checks from your Trustee each year. You will want to retain records of the contributions in case you are audited.
- Tax Reporting – At the end of the year your IRA Trustee will issue a 1099-R for your taxes, however, there is no place on the form that denotes the distribution taken was a QCD. This is not the fault of your Trustee. You need to let your tax preparer know what amount of your RMD is a QCD so they can enter it correctly on your tax return. If you do not do this, you may pay tax on the full amount of your IRA distribution.
Other Practical Considerations
- QCD’s can be more involved depending on your IRA Trustee
- You need to plan ahead each year
- The charity may remove your name from their mailing list as not all IRA Trustees will report the gift came from you
- You cannot make a QCD from your company retirement plan, only an IRA
- If you have made non-deductible contributions to your IRA, or have been contributing to your IRA past age 70 (called the QCD Anti Abuse Rule), you should speak with your Accountant prior to electing a QCD. There are specific rules surrounding both these scenarios that are beyond the scope of this post, but important to evaluate before moving forward
If you are charitably inclined, using a QCD is a great way to benefit charity(ies) and receive some benefit yourself. As giving is an important part of our stewardship responsibility, this strategy may be an option worthy of consideration.
Points to Consider
1. Talk with your Accountant and Financial Advisor to see if this is the best decision for you.
2. If you decide to use a QCD, contact the charity(ies) to let them know about your change of giving so they can plan accordingly.
3. Don’t procrastinate. If the charity hasn’t cashed the check by 12/31 it may cause a taxable event for you.
4. Review your decision annually, as the standard deduction, IRMAA and the tax code will change.