Are You Retired and Charitably Inclined? Try This Strategy!
If you’re at least age 72, you probably know that you’re in what’s called “Required Minimum Distribution” territory. This is when you’re required to take at least a minimum amount of money from your tax-deferred retirement accounts and pay taxes on that amount.
For people with especially large accounts, taking even the minimum can result in a much larger tax bill than they’d anticipated. Of course, if you need those funds to pay your monthly expenses, there’s not much you can do except bite the bullet and pay the taxes owed. But if you don’t need the money, the RMDs are really nothing more than an added tax bill for you.
This is where something called a Qualified Charitable Distribution, or QCD, may be able to help. The only requirements here are that you don’t need the IRA distributions to fund your living expenses, AND you already plan on giving money to a qualified public charity sometime during the tax year.
So how does this strategy work? It’s pretty simple, really. Once you’re at least age 70 ½, you decide how much money you want to give to your qualified charity (or multiple charities). You then instruct your IRA custodian to transfer that amount of money (or some portion of it) directly from the IRA to that charity, bypassing you in the process completely.
By doing it this way, by giving the money directly to the charity from the IRA, that amount will not appear on your tax return as a taxable event to you. You can give as much money as you want, up to a combined $100,000 for the entire tax year, and that amount will count toward satisfying your RMD.
The combined result is this: your charity gets the money you wanted them to have, AND it counts towards your Required Minimum Distribution for this year for your IRAs, AND it’s not part of your Taxable Income for that year.
You might be asking, why is it better to do it this way, through a QCD? What if you just took the RMD for yourself as normal, and then just turned around and wrote a personal check to the charity? Logic would dictate that the RMD would be taxable coming in to you, but the money you’re sending to the charity would be potentially deductible going out, so the two of them would just cancel each other out, right? Well, logic and tax law rarely go together.
What really happens is that when you take the RMD for yourself and add it to your tax return, as you would normally do, that income is counted “above-the-line,” meaning it adds to your adjusted gross income for the year. If you’re able to itemize (and most people can’t do that anymore), your charitable deduction happens farther down your tax return, below the AGI line. When your Adjusted Gross Income goes up, there’s a good chance you’ll increase the taxability of your Social Security, or you can push long term capital gains from the 0% bracket to the 15% bracket.
A higher AGI can also mean an increase in your Medicare premiums, as well as your Medicare surtax on capital gains. It may also phase out some of your itemized deductions, among other things. So doing it the non-QCD way creates a kind of ripple effect across your tax return, and not in a good way.
By doing a Qualified Charitable Distribution, your AGI does not go up, which means you stand a better chance of avoiding those issues I mentioned a moment ago. And here’s a bonus: if you don’t itemize and thus can’t deduct your charitable contributions, by doing a QCD, you get what amounts to a de facto deduction.
Here are a few rules to keep in mind when you’re considering a Qualified Charitable Distribution:
- The IRA owner must be at least age 70 ½ to do this.
- There’s a $100,000 per year donation limit through a QCD per taxpayer, so a married couple can each do up to $100,000 if each distribution comes from his or her respective IRA.
- This works only for individual IRAs, NOT from any kind of employer-sponsored retirement plan, like a 401(k).
One other thing to watch out for. The 1099R that you receive from the IRA custodian will not list the QCD as a separate distribution. It’s just part of the total distribution that was sent from your IRA. Since there’s no code, your tax preparer won’t know about it and they’ll just list it as part of your normal “Taxable” distribution. So make sure you tell your tax preparer that you did the QCD.
And one final thing here, which is a change from a few years back. If you’ve made any contributions to your IRA post age 70 ½, which we can do now thanks to the SECURE Act, those contributions have to come out first. They can’t be turned around and used as QCDs. So the rules effectively require a “LIFO” treatment that ensures post-age-70 ½ contributions will first and foremost be used to reduce your ability to do future QCDs.
But hey, that’s just a minor detail. A QCD still can make sense for anyone who’s charitably inclined, and who doesn’t need their RMD to fund their living expenses. If you are over 70 ½ and make charitable donations, you should be using QCDs. If you want to know whether you may benefit from this QCD strategy, we do this kind of thing for our clients every single day at Lucia Capital Group. How can we help you the most? Just give us a call.
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the information presented serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.
You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.
IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.
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Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.