Giving season is upon us and taxpayers of all kinds will be rushing to make charitable contributions before year’s end. To contextualize the significance of giving during this time of year, close to 1 in 3 donors conduct their giving in December, while more than 1 in 10 wait until the last three days of the year to do theirs. What’s more, charitable giving is on the rise, having increased by 9% last year and 19% over the past three years. Needless to say, it’s become an increasingly important component of the financial planning process for many Americans.
As we approach the holidays, you may be wondering how best to deploy your funds and support the causes you believe in. A Qualified Charitable Distribution, or QCD, could be a strong option.
By taking advantage of a Qualified Charitable Distribution, taxpayers can fund a charitable gift of up to $100,000 using their IRA instead of taking a Required Minimum Distribution. 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.
Revisiting Required Minimum Distributions
The IRS requires taxpayers 72 and older to make regularly-scheduled withdrawals from their tax-deferred accounts in the form of Required Minimum Distributions (RMDs). Retirees must take RMDs each year thereafter, slowly whittling down their account balances over the course of retirement.
The size of your RMD is usually a function of your age and retirement account balance. To find your RMD, take your account’s year-end fair market value and divide it by the applicable distribution period. The distribution period is a number prescribed by the IRS each year (starting at 27.4 and going all the way down to 1.9) that is meant to represent years of life expectancy. This means that as your age increases, the amount you must withdraw as part of your RMD also increases.
There is an exception to this method of calculating RMDs. If your spouse is ten or more years younger than you and is the sole beneficiary of your account, you will calculate your RMD using a different table.
RMDs can cause headaches for retirees because the amount that must be withdrawn has to be calculated on a case-by-case basis and, most importantly, gets treated as ordinary taxable income. Each distribution you take is taxable under your standard federal income tax rate, which could be as high as 37% for 2022. 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 Those Pesky RMDs
For investors interested in avoiding these required retirement account withdrawals, either because they don’t need the funds or because they’d derive more benefit from lowering their taxable income, an alternative route exists.
Enter the Qualified Charitable Distribution, or QCD—a method for managing 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.
Making a Qualified Charitable Distribution is straightforward. 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 won’t 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 Required Minimum Distributions until they turn 72.
- 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, qualified charitable distributions 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, as is frequently done with foundations and donor-advised funds.
- To qualify as a QCD, funds must be distributed from the IRA (or another tax-deferred account) to the recipient. Funds distributed directly to the IRA owner and then donated to charity will not qualify.
- For 2022, 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 a Required Minimum Distribution 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 $5000 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 Qualified Charitable Distributions
Qualified Charitable Distributions 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 a handful of the potential benefits you could enjoy by making a QCD.
Alternative to RMDs
Provides another use for your Required Minimum Distributions 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—or another kind of tax-deferred account—which potentially reduces the size of your future RMDs and lowers the amount you’re ultimately forced to surrender 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. Further, contributing to an IRA could lower the amount you’re able to deduct as part of your QCD.
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 translates 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 charitable foundation, you can gift a lump sum directly to a qualified organization you’ve identified. This could be a meaningful angle to consider for those concerned with focusing their philanthropic efforts or building their legacy through magnanimity.
The Takeaway
Qualified Charitable Distributions (QCDs) represent an alternative to Required Minimum Distributions for IRA owners. Taxpayers have an opportunity to write off a portion of their taxable income each year by giving to a charitable organization of their choice, potentially lowering their tax burden for the year the QCD is made.
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, your financial advisor can help you assess your options and identify the right course of action for you.
Disclosure:
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
References:
Gomez, Ronnie. “Year-End Giving Statistics Every Fundraiser Should Know.” Neon One, August 25, 2022. https://neonone.com/resources/blog/year-end-giving-statistics/.
“Qualified Charitable Distributions (Qcds): Planning Your Ira Withdrawal.” Fidelity. Accessed October 11, 2022.
https://www.fidelity.com/building-savings/learn-about-iras/required-minimum-distributio ns/qcds.