Updated: Sep 24, 2021
Recent changes in tax law have given new importance to a charitable giving technique which has been around for many years. The Qualified Charitable Distribution (QCD) allows those over 70.5 to give up to $100,000 per year directly to charity. The amount of the QCD counts towards your yearly Required Minimum Distribution (RMD) and it will lower the taxable amount of your IRA distribution, potentially to zero
Many people find that they aren’t ready to begin taking distributions from their IRA at 72. Maybe they have a pension or other income that, along with Social Security, covers their spending needs. They’re altruistic people and enjoy supporting organizations which are important to them. We have several clients like this and many of them have found it beneficial to use QCD’s as their main form of charitable giving. With a bit of planning, they can both support charity and keep from taking a tax hit from the RMD that they don’t need. It can be a win-win situation for all involved.
In the past, it sometimes made sense to take the RMD and then write a check to charity. Any contribution could then be used to itemize deductions. While this is still possible, many taxpayers are finding it harder to find enough deductions to make itemizing deductions worthwhile. The increased standard deduction, now $26,500 for couples over the age of 65, has made it harder for many to itemize their deductions. When clients do elect to itemize, they often find that donations fail to give them an exact matching deduction due to slippage. This slippage comes from potential additional Social Security taxation, the phaseout of itemized deductions, the addition of a 3.8% Medicare surtax or increases in cost for Medicare Parts B and D. Giving using a QCD bypasses all these issues and keeps the amount of the distribution from ever showing up as income. There is no issue with slippage when using a QCD.
Let’s look at an example.
Bill and Betty are 72 years old. Between the two of them, they have $45,000 of Social Security benefits, $20,000 of portfolio income, $40,000 from Andrew’s military pension, and Andrew faces a $29,296 RMD from his $750,000 IRA. In addition, the couple wish to make a significant bequest to their alma mater this year and have pledged a $29,296 donation (to offset their looming RMD obligation).
If the couple commits the $29,296 QCD directly to the, the couple’s AGI is $20,000 (portfolio income) + $38,250 of taxable Social Security benefits + $40,000 pension = $98,250. Their itemized deductions include paying $3,500 in state income taxes, $2,000 in property taxes, and $8,000 in investment management fees (which are limited to $7,035 in excess of the 2%-of-AGI floor). Thus, their total deductions are $12,535, less than the $26,500 standard deduction. With the standard deduction, their taxable income is $71,750. Based on the 2018 married filing jointly tax tables, this puts the couple in the 12% tax bracket, with a total tax liability of $8,229.
If the couple instead decided to take the RMD and then donate the same $29,296 to charity, their situation would look like this:
The couple’s AGI is $20,000 (portfolio income) + $38,250 of taxable Social Security benefits + $40,000 pension + $29,296 (RMD) = $127,546. Their itemized deductions include paying $3,500 in state income taxes, $2,000 in property taxes, and $8,000 in investment management fees (which are limited to $7,035 in excess of the 2%-of-AGI floor). They would also deduct the $29,296, subject to the 2% of AGI floor, leaving a deduction of $26,745.08. Thus, their total deductions are $39,280.08, making their taxable income $88,265.92. Based on the 2018 married filing jointly tax tables, this puts the couple in the 12% tax bracket, with a total tax liability of $11,297.50.
The mechanics of making a Qualified Charitable Donation are simple. All you need to do is direct your advisor to send a check from your IRA, to you, with your desired charity as the recipient. You can then forward the check to the charity. At the end of the year, you will need to let your tax preparer know the amount which was transferred as a QCD. You will still receive a 1099-R from your custodian which shows the distributed amount; you’ll just give your tax preparer a copy of your receipt from the charity showing how much you contributed and you should be set. One consideration to note is that the check must be made out to the charity directly. If the check is made out to you, you will be taxed on that amount.
If you’re over age 70.5, you should consider using a QCD as part of your withdrawal strategy. If you aren’t there yet, now is a good time to begin thinking about how you can position yourself to take advantage of these rules in the future. Start by evaluating how much you have saved in tax-advantaged accounts and then think about your plan for turning your savings into income that can support your retirement lifestyle. By using, or preparing to use, a QCD, you can meet your RMD requirement and support your favorite charities, all while saving money on taxes both today and into the future.