Whether your philanthropic efforts involve donating time, talent, or resources to causes that you are passionate about, they likely bring a deep sense of enrichment and joy to your life. Alongside the personal and social benefits philanthropy offers, it can also impact your financial wellbeing. This includes tax benefits that, when used properly, can help you make the most of your charitable efforts.
One such example is a qualified charitable distribution (QCD). While most people donate to charities they care about via cash or check, QCDs can provide a way to donate your money while also providing you with some meaningful tax relief.
What are Qualified Charitable Distributions?
Qualified Charitable Distributions allow individuals who are 70 ½ years old or older to donate money directly from their IRA account to one or more qualifying charities of their choice, rather than being forced to take out their required minimum distributions (RMDs). Put simply, a QCD is a donation made directly from an IRA to a charity that qualifies.
One of the biggest benefits of a qualified charitable distribution is that it allows you to donate all or a portion of your required minimum distribution (RMD) directly to a charity they love, so long as it’s a qualified charity. This method of donating minimizes a retiree’s annual taxable income while maximizing their donation strategy. Additionally, since QCDs reduce the overall balance of your IRA, there’s a strong likelihood that they’ll reduce your RMD for future years.
SEE ALSO: Charitable Gifting Strategies
QCDs don’t just benefit your bottom line. They can also help you maximize your philanthropic efforts. For those who itemize giving on their taxes, QCDs are not counted toward the deductible of the maximum amount, meaning the amount of QCDs you make can go above and beyond those limits. This can potentially enable you to give a larger charitable gift than you’d otherwise be able to if you were to use more traditional methods, such as writing a check or gifting cash.
As is the case with most strategies that involve a tax benefit, there are strict rules that you need to follow for your donation to be considered a QCD. In order to fully understand QCDs, you must first fully understand the required minimum distributions. Beginning at age 72, account holders of IRAs are legally required to take RMDs each year, even if they don’t want or need the funds at the time of the withdrawal. The amount taken out with the RMD then becomes taxable income for the account holder. If it’s a significant amount of money that’s distributed out, this income increase could potentially push you into a higher income tax bracket. It also runs the risk of ruining other tax deductions or tax-saving strategies you may be depending on.
This is what makes QCDs a perfect option for those with a generous heart looking to offset the pitfalls of an IRA. By enabling you to fulfill your RMD by making a direct transfer of up to $100,000 to one or more qualifying charities, QCDs can protect you from being launched into a higher tax bracket or upending your tax savings strategy.
It’s important to note that in order for your donation to qualify as a QCD, your distribution must come directly from your IRA to the qualified charity. If you take the distribution as cash, or a check made out to you, and then donate that to the charity, your donation won’t qualify QCD purposes. The money must be a direct transfer that never passes through the hands of the IRA account holder. Rather, the IRA custodian can either send a check directly to the charity or the account owner, who then hands it over to the charity.
Charities are deemed as qualifying charities by the tax code. Currently, donor-advised funds and private foundations and their supporting organizations do not qualify as a charity for QCDs. We highly recommend you check that the organization you’re choosing to support is qualified to accept QCDs before you make your donation.
When it comes to your qualified charitable distribution, you cannot claim the value of your donation as a separate charitable deduction. QCDs are not taxable distributions, so deducting them would result in a double benefit. The flip side of that, however, is that since a QCD isn’t a deduction, you don’t have to itemize to benefit from it. If you’re taking the standard deduction, that can be a significant benefit.
As mentioned above, the cap on QCDs is $100,000 for IRA account holders 70½ years old or older. For married couples, each spouse is allowed to make a QCD up to this limit for a protentional total of $200,000 annually. This donation limit applies to the grand total of all QCDs taken from all IRAs that an account holder has each year – it is not per IRA account. This means that you can make one large donation or multiple smaller donations throughout the calendar year, as well as make QCDs from more than one IRA account, should that be an option available to you.
In addition, all IRA account types qualify: traditional, inherited, inactive Simplified Employee Pension (SEP), and inactive Savings Incentive Match Plan for Employees (SIMPLE) IRAs. However, you cannot do a qualified charitable distribution from a 401(k) or if the SEP IRA or SIMPLE IRA you’re using is actively receiving employer contributions.
It’s important to remember that the point of the QCD is to facilitate the donation of your RMDs in order to offset your taxable income. That being said, you are allowed to donate more than your annual RMD limit, so long as it doesn’t go over the $100,000 threshold. However, unlike donations of cash and appreciated securities, where a large donation can be made in one year and the tax benefits can be carried forward, any excess amount that you donate in a QCD will not roll over and count for your next year’s distribution. This is also contradictory from contributions you may make to a donor-advised fund or foundation, which doesn’t qualify for a QCD but does allow you to front-load giving in a high-income year and use those funds to support other charities in the future.
Why do Qualified Charitable Distributions Matter?
Ultimately, QCDs work to reduce your taxable income, which may help decrease any federal tax liabilities you would otherwise be faced with. While this is certainly a helpful bonus, a lower taxable income also brings with it the promise of additional tax savings. For example, it could reduce taxes on Social Security, Medicare Part B, and IRMAA surcharge since all of these elements are determined based on your taxable income. This could potentially save you a significant amount of money, having a cumulative effect on many other aspects of your financial plan. Saving money on various taxes frees up money that you can use to do things like donate more, pay off debt, cover healthcare costs, or cushion your savings.
The benefits of QCDs are fantastic not just for you, but also for the charities that you care about. Before you start donating, make sure to take some time to consider how your gifts might fit into a multi-year strategy. Spreading your donation out over several years could help you take full advantage of tax reductions while simultaneously increasing the value of your donation.
Though qualified charitable distributions can be a great option in the right circumstances, they’re not necessarily the right choice for everyone. For instance, say you have securities that have been growing in value since you bought them. It would most likely make more sense, and provide you a greater tax benefit if you donated your securities to a charity of your choosing rather than using a qualified charitable distribution. Or, if you prefer the benefits of donating to a donor-advised fund where you can take a tax deduction in the current year and support charities long-term, then a QCD may not be the best option for you.
Ultimately, if you’re looking to maximize your philanthropic efforts, you should consider speaking to a CPA or financial advisor about the options available to you. Working with a professional can ensure that you’re minimizing your tax liability and maximizing the value and impact of your gift to its greatest potential. If you’re interested in sitting down with one of our financial advisors to build a charitable giving strategy or combination of strategies that are right for your situation, please contact us today.