Angel and Bob are in their early 70s and find deep fulfillment through philanthropy. They’ve been donating cash to their favorite charities. Their mortgage is paid off, Angel sold her business, and neither of them are working full-time. They typically withdraw money from their taxable investment account, take their annual Required Minimum Distribution, and then write checks to their favorite charities.
Little did they know, there’s a better way to fulfill their philanthropic goals.
If you’re a follower of our blog you know we love to help people become savvier givers. You’ve probably already read our posts on donating appreciated stock, using a Donor Advised Fund to execute a charitable bunching strategy, or building out a family giving legacy.
What you may not be aware of is how you can reduce your taxable income dollar for dollar (vs. “only” taking a deduction against your income) by making a qualified charitable distribution from your traditional IRA. This is helpful because many people no longer itemize their deductions in the first place. It also reduces your Adjusted Gross Income which
What is a Charitable Qualified Distribution?
If you’ve never heard of this strategy, you’re not alone. When you are over age 70 ½ you are eligible to make a qualified charitable distribution (QCD) of up to $100,000 each year from your pre-tax* IRA to your favorite 501(c)3 charitable organization(s). Post-SECURE Act you are not obligated to take a Required Minimum Distribution (RMD) until age 72. However, they left the age at which you can make a Qualified Charitable Distribution at 70.5. Which is particularly good news if you have a large IRA and are staring down significant Required Minimum Distributions later in life.
If you are 72 or older and you are required to take an RMD, you can use a Qualified Charitable Distribution to count towards your RMD. However, if you already took an RMD earlier in the year, you cannot undo the earlier RMD and then use a Qualified Charitable Distribution to count for your RMD. So plan carefully.
In order to count this as a Qualified Charitable Distribution the check must be sent directly to the charity. You cannot take a distribution and then turn around and send that same amount to your charity of choice.
Why make a qualified charitable distribution?
Why should you take the extra step of donating directly from your IRA instead of just writing a check?
Cold hard cash.
With the Tax Cuts and Jobs Act most Americans no longer itemize on their taxes. This is in part due to the State and Local Tax limit of $10,000 that can be deducted on your federal tax return and in part because the standard deduction was increased. People who make very large charitable contributions still might take the standard deduction. This means you won’t see much benefit from a tax perspective for donating to charity. While we know people who donate to charity typically do so because they have causes they want to support, it doesn’t hurt to save money on taxes when you can.
By donating directly from your IRA you can reduce your taxable income before it even hits your tax return. Let’s show an example of a married couple who are both 73. They typically take the standard deduction ($25,900 in 2022) plus the extra deduction for those 65 and older ($1,400 each in 2022).
|No QCD||With a QCD|
|Required Min. Distributions||$100,000||Required Min. Distributions||$100,000|
|Cash charitable donations||$15,000||Qualified Charitable Distribution||$15,000|
|Social Security (Gross)||$32,000||Social Security (Gross)||$32,000|
|Est. Adjusted Gross Income||$127,200||Est. Adjusted Gross Income||$112,200|
|Standard Deduction + Additional for 65+||$28,700||Standard Deduction||$28,700|
|Est. Taxable Income||$98,500||Est. Taxable Income||$83,500|
|Marginal Tax Bracket||12%||Marginal Tax Bracket||22%|
|Est. Total Federal Tax||$13,288||Est. Total Federal Tax||$9,993|
As you can see, careful financial planning saved this couple an estimated $3,295 in federal taxes with just a simple change in how they were giving to their favorite charities.
A few prickly points around QCDs
First and most importantly, the money must go directly to the charity from your IRA. You can not take “custody” of the funds. This means the check must be payable to the charity.
This introduces a little wrinkle, some IRA custodians don’t do a great job of noting qualified charitable distributions on their tax reporting forms. It is up to you to tell your CPA or tax preparer that you made a QCD. At Spark we provide tax letters to all of our clients in January and February to share with their tax preparers to prevent details like this from being missed.
(Your financial planner doesn’t provide you with a tax prep letter? Let’s talk.)
Remember, if you want your Qualified Charitable Distribution to count as your Required Minimum Distribution those funds need to come out first from your IRA and they must still meet the December 31st deadline.
You cannot make a QCD to a Donor Advised Fund or Private Charitable organization.
You cannot receive any benefit from making a QCD to a charity (i.e. you cannot receive gala tickets, gifts, etc. in exchange for your contribution).
Final Plug for Qualified Charitable Distributions
Qualified Charitable Distributions are a tremendous tax planning tool, however, a QCD may not make sense for your situation. Just because you legally can donate $100,000 from your IRA to charity every year does not mean you should. Or perhaps you have a significant stock concentration in a taxable account that needs to be dealt. Talk to your financial planner about how your charitable goals fit into your overall financial plan.
This is not tax or financial advice. Please talk to your tax professional or financial advisor before making any changes.
*You can make a charitable contribution from a Roth IRA as well, but since Roth distributions are generally already tax-free there’s no additional tax benefit to using the Roth IRA. Talk to your CPA or financial advisor before making any changes.