Should You Make Qualified Charitable Distributions from Your IRA?
If you have an IRA, SEP IRA, SIMPLE IRA, or similar retirement plan, you have no doubt been made aware that you must take required minimum distributions (RMD) from the plan when you reach the age of 70 ½. You may withdraw more than the RMD, but withdrawing less carries a heavy tax burden: a 50% tax penalty on any part of the RMD you fail to withdraw. This penalty puts teeth in the "required" part of the phrase.
When you receive your RMD, it will be taxed to you as ordinary income, with the exception of any portion on which you previously paid tax. Because distributions are treated as ordinary income, they may bump you into a higher tax bracket or cause related problems, such as raising the amount of your Social Security benefits that is taxable, or causing your Medicare premiums to go up. If you need the income your RMD would provide, that's one thing. But what if you would prefer to forgo that extra income and the tax headaches it could bring? Is there an alternative to taking an RMD that won't result in penalties?
Fortunately, yes: the Qualified Charitable Distribution (QCD). With a QCD, you can comply with distribution requirements, avoid tax penalties, and do good with your hard-earned, carefully-saved money.
What Is a Qualified Charitable Distribution?
A Qualified Charitable Distribution was made possible by a law enacted in 2015. Through this law, Congress made it possible for individuals who are older than 70 ½ to donate up to $100,000 per year to a qualifying charity directly from an IRA or similar account. (However, payments from a 401(k) or 403(b) are not eligible for QCD status.) This distribution, the QCD, is not considered taxable income, unlike an RMD that is paid to the individual.
If supporting a favorite charity is one of your goals in retirement, the use of a QCD allows you to achieve that goal while also reducing your tax liability. What's more, you do not need to itemize deductions on your tax return in order to make use of a QCD. This is relevant because the federal Tax Cuts and Jobs Act (TCJA) passed in 2017 raised the standard deduction, meaning that it will benefit fewer people to itemize on their income tax returns, as it may be to their advantage to take the now-higher standard deduction. Using the QCD allows you to be philanthropic at the same time as you reduce your taxable income dollar-for-dollar.
Even if you still plan to itemize your deductions, making a QCD can offer you a tax advantage. A QCD lowers your adjusted gross income (AGI), which in turn lowers the threshold above which you can begin to claim medical expenses.
What if you have taken your RMD for this year? Can you still make a QCD, perhaps using it to offset the taxable income from the RMD? Yes and no. You can still make a QCD and receive the tax benefits from it, but the income from the RMD will still be counted as taxable income.
Requirements for Qualified Charitable Distributions
As you might expect, you must comply with IRS requirements to take advantage of the QCD. These requirements include:
- Distribution must be made to a 501(c)(3) organization. Distributions to private foundations and donor-advised funds do not qualify.
- The charitable distribution must be made directly from the IRA trustee to the charitable organization. Distributions made to you, which you then donate to a charity, do not qualify.
- You must be 70 ½ or older to make a QCD.
- You must meet deadline requirements in order for a QCD to be counted toward your current year RMD. The deadline is typically December 31, but check with your tax advisor.
As with most things related to taxes and charitable donations, you should request confirmation from your chosen charity that the distribution was timely received from the trustee of your IRA. This will allow you to make sure that the amount of the distribution is properly excluded from the amount of your taxable income when you file your tax return.
If you have questions about Qualified Charitable Distributions that this article didn't answer, or would like more information, contact an attorney with experience in tax law and financial planning.
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