The holiday season is a time for reflection and giving back, and many people choose December as the month for making their charitable donations. Philanthropic giving can make a huge difference to a charity or nonprofit, but it can also make a difference to your taxes if you take advantage of certain benefits available to you.
For seniors, one of these opportunities is making Qualified Charitable Distributions (QCDs) from their IRAs. If you’re already taking Required Minimum Distributions (RMDs), this may be a good strategy for you.
What Is a Qualified Charitable Distribution?
A QCD is a direct donation to an eligible charity from your IRA. By donating straight from this account, you can avoid paying taxes on the donation, which lowers your overall taxable income for the year.
There are the 3 requirements to do this:
1. You must be at least 70-½ years old.
This is the age when you have to start taking RMDs from your IRA, even if you don’t need the money. RMDs are taxed as ordinary income, so you pay taxes according to the bracket you’re in that year. Depending on your situation, taking an RMD could push you into a higher tax bracket than anticipated.
This is where QCDs come in. Unlike RMDs, you don’t pay income tax on QCDs, so giving the money to charity can lower your taxable income for the year.
Foregoing RMDs is not the option! Doing this could result in a 50 percent penalty fee on the amount you didn’t take out. So, if your RMD is $10,000 and you don’t take it, you could end up paying a $5,000 tax straight to the IRS.
2. You must have a qualifying IRA.
Certain rules apply, but you typically qualify for a QCD if you have a:
- Traditional IRA
- Inactive SIMPLE IRA (you and your employer no longer contribute)
- Inactive SEP-IRA
- Inherited IRA
If you’re not sure if your IRA qualifies, contact your financial advisor. It’s wise to discuss any financial decisions that could affect your overall financial picture.
3. You have to donate to an IRS-approved charity.
You can’t give a QCD to any old organization that comes your way. It must be classified as a 501(c)(3) and be eligible to receive tax-deductible donations.
Beware, there are some common charities that don’t qualify for QCDs. These include:
- Private foundations
- Donor-advised funds
- Supporting charities
If you find a charity you want to give to, look it up in this IRS online database to make sure it’s approved.
How Do I Make A QCD?
In order for a donation to qualify as a QCD, it must be transferred directly from your IRA custodian to the eligible charity. It can never pass through your hands. Talk with your financial advisor about how the process works.
Your IRA custodian uses Form 1099-R to report QCDs from non-inherited IRAs to the IRS. For inherited IRAs, it’s reported as a death distribution.
There’s a chance that the IRS may audit you, so keep track of as much documentation as possible. Make sure you get receipts when you make contributions and keep copies of any paperwork you receive.
Who Are QCDs Best For?
QCDs are a great tax strategy for retirees who:
- Are required to take RMDs, but don’t need the money and would otherwise be pushed into a higher tax bracket
- Are looking to reduce their IRA balance to lower future RMDs
- Would like to make a large, tax-free contribution to charity
- Don’t want to donate using a donor-advised fund or foundation
- Want to reduce taxes on Social Security or avoid the 3.80 percent Medicare tax if they’re a high-income earner
3 Facts You Should Know About QCDs
1. Your QCD Can Exceed Your RMD
You can give more than your RMD to charity, as long as the total amount doesn’t exceed $100,000 in a single year.
This limit applies to all QCDs across all retirement accounts. For example, you can donate $100,000 to one charity from one retirement account or $10,000 to 10 charities from three retirement accounts, as long as it doesn't exceed $100,000 total.
The only exception is if you’re married and file jointly. In this case, your spouse could also contribute up to $100,000 from his or her own IRA.
2. States Have Different QCD Rules
Just because QCDs aren’t subject to federal tax, it doesn’t mean you won’t pay state tax. Each state has its own rules and regulations regarding QCDs, so it’s best to speak with a financial advisor in the area in which you live to understand how they may affect your individual situation. (Remember, financial planning in San Antonio, TX is different that in other areas. Read this recent blog post to learn what you can expect in the San Antonio area.)
3. It’s Usually a Bad Idea to Make QCDs From a Roth IRA
You may be eligible to make QCDs from a Roth IRA under certain circumstances, but it’s usually a bad idea. Roth IRAs are not subject to RMDs, and any money you take out is tax-free. But QCDs are an exception. If you make a QCD from this account, you may pay unnecessary taxes on it.
Talk with a financial advisor about your Roth IRA to make sure this giving strategy is the best course of action for your situation.
How We Can Help
Giving to charity can benefit both the giver and the receiver. Helping someone in need may make you feel good, but it can also help you leave behind a legacy and even lower your taxable income if done strategically.
At PAX Financial Group, we help many retirees give back to their communities in a tax-efficient way. If you’d like to learn more about who we are, what we do and how we can help you lead a meaningful life in retirement, contact us today.
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