Last month, we discussed creating your philanthropic philosophy – a personal, repeatable framework to guide charitable giving. This month, we’ll cover the Qualified Charitable Distribution (QCD). This gifting strategy ensures that you apply your philanthropic philosophy in the most tax-efficient way.
If you want to sit back and watch me walk through this, along with some visual examples, check out the video below.
What is a Qualified Charitable Distribution (QCD)?
A qualified charitable distribution (QCD) is a charitable giving technique that allows individuals who are 70 1/2 years old or older to donate funds directly from their qualified individual retirement account (IRA) to a qualified charity without incurring taxes on the withdrawal.
In true tax talk, I used qualified three times in the last sentence, so I feel compelled to spell out what the three definitions mean:
- Qualified Charitable Distribution – you must be over 70 1/2, and the donation must be made directly from the IRA custodian to the charity.
- Qualified Individual Retirement Account – the account you’re sending money from must be a Traditional IRA, Inherited IRA, SEP IRA, or SIMPLE IRA.
- Qualified Charity – the charity must be a 501(c)(3) organization.
The Benefits of Qualified Charitable Distributions (QCDs)
Making a QCD offers several advantages to optimize your charitable giving strategy. One of the key benefits is that it allows you to fulfill your required minimum distribution (RMD) obligations while supporting charitable causes. When making a QCD, the donated amount is not included in taxable income, providing a dual advantage of reducing your tax liability and supporting charitable organizations. By reducing taxable income, you may enjoy a ripple effect across various areas of your tax obligations, such as:
- Taxation on Social Security benefits: A lower taxable income can lead to a reduced amount of Social Security benefits subject to taxation, potentially resulting in additional savings.
- Itemized medical expenses: Lower taxable income may allow you to deduct a higher portion of your itemized medical expenses, providing further tax relief.
- Medicare Part B and D premiums: A reduced income used to calculate Medicare premiums can result in lower premium payments for Medicare Part B and D.
- Modified Adjusted Gross Income (MAGI): A lower MAGI can have an impact on various credits and may reduce your liability under the Net Investment Income Tax.
- Standard deduction benefit: If you do not have sufficient deductions to itemize, utilizing a QCD allows you to benefit from the standard deduction, which increased significantly in 2017 after the implementation of the Tax Cuts and Jobs Act (TJCA).
Making a Qualified Charitable Distribution (QCD)
Now that we understand the benefits of a QCD, let’s dive into the process of making one. For client families, the QCD process often begins with creating a charitable gifting strategy at the start of the year. This strategy involves determining the amount and frequency of gifts and identifying the philanthropic organizations that will receive them. Once this is established, we can proceed with the following steps to initiate a QCD:
- Gather information: Collect the necessary information about the charitable organization, such as their address, contact details, and Employer Identification Number (EIN).
- Direct transfer: Schedule a transfer of funds directly from the IRA custodian to the qualified charitable organization. It’s essential to ensure that the donation is made directly from the IRA custodian to the charity to meet the requirements of a QCD.
- Maintain paperwork: Retain a copy of the gift acknowledgment from the charitable organization. At the start of the year, you’ll receive a 1099-R which will not differentiate QCDs from normal distributions. It will be up to you to notify the IRS/your accountant of the portion that was gifted via QCD in order to have that amount removed from your taxable income for the year.
Here are a few additional details to keep in mind when making a QCD:
- The QCD strategy has a $100,000 per year per individual limit. It’s important to note that starting in 2024, this limit will increase with annual inflation adjustments.
- The charitable organization receiving the QCD cannot be a donor-advised fund (DAF). This limitation might be frustrating if you prefer to donate through DAFs, but it is an important aspect to consider when planning a QCD.
- The deadline for making a QCD is December 31 of each year. Ensure that the transfer is completed within the calendar year to take advantage of the associated tax benefits.
Determining Eligibility for a Qualified Charitable Distribution (QCD)
To determine whether you are eligible to make a QCD, there are three primary considerations to take into account:
- Age: You must be at least 70 1/2 years old. This may or may not be the age at which you’ve started Required Minimum Distributions (RMDs). The two versions of the SECURE Acts passed in the last few years changed the required beginning date for many. For a summary of the latest RMD changes, check out our post, “How Has the SECURE Act 2.0 Changed RMDs?“
- IRA Account Type: QCDs can only be made from specific types of IRA accounts. Eligible account types include Traditional IRA, Inherited IRA, SEP IRA, and SIMPLE IRA. It’s crucial to be aware that QCDs cannot be made from Roth IRAs or other after-tax accounts.
- Direct Donation: The donation must be made directly from the IRA custodian to a qualified charitable organization, as described above. This ensures compliance with the QCD requirements.
To simplify the process of determining QCD eligibility, you can refer to our Can I Do a Qualified Charitable Distribution From My IRA flow chart, which provides a step-by-step guide.
To better understand how QCDs work in practice, let’s explore two hypothetical scenarios:
Case 1 – Sean Konnery
First up we have Sean Konnery, who is single, 75, and earns $80,000/year from his consulting job with another $30,000 from Social Security. Sean wants to make a charitable donation of $10,000 to his favorite nonprofit organization, Drs. Without Borders. Instead of making a cash donation, Sean chooses to utilize a QCD from his traditional Individual Retirement Account (IRA) to fulfill his philanthropic goal.
By utilizing a QCD, Sean can directly transfer the $10,000 from his IRA to the nonprofit organization. As a result, the amount transferred through the QCD is excluded from Sean’s taxable income. This exclusion allows Sean to:
- Can fulfill his Required Minimum Distribution (RMD) obligations from his IRA while supporting a charitable cause
- Maximize the standard deduction. Because his gift is below the standard deduction, it’s still more beneficial for him to claim the standard deduction than itemize to claim this cash gift
- Keeps Sean in the 22% tax bracket, saving him $2,288 in total tax
The timing on which you need to start RMDs changed late last year, thanks to the SECURE Act 2.0. (If you’re wondering when you need to start RMDs, check out our post, How Has the SECURE Act 2.0 Changed RMDs?) This gifting technique is available to anyone over the age of 70.5, so even if you aren’t subject to RMDs yet, you still may benefit from utilizing a qualified charitable distribution to meet your gifting goals.
Case 2 – Jordan and Brian
Jordan and Brian are 73; both worked for the state, and their income consists of a PERS pension, Social Security, and dividends from their investment portfolios. They earn more than they spend, and therefore, the $50,000/year required minimum distributions they’re subject to are more of a tax burden than needed cash flow. They want to gift $50,000 to the YMCA, where they both spent a lot of time as kids.
By utilizing a QCD, Jordan, and Brian can directly transfer the $50,000 from their IRAs to the YMCA. This means they have $50,000 less in total income than they would have had otherwise. Gifting in this way allows them to:
- Fulfill their RMD while supporting the YMCA
- Save $6,754 in tax by not having to claim that $50,000 on their return
- Avoid $1,872 in Medicare surcharges by keeping their income below the $194,000 threshold.
Medicare surcharges can be a real surprise. Proactive planning can go a long way to avoiding these altogether, particularly if your income is close to the rate increase amounts. To learn more about those amounts and what can be done about Medicare surcharges, read our recent blog, Can I Appeal Medicare Surcharges?
Qualified Charitable Distributions (QCDs) provide a simpler and more convenient way to support charitable causes while potentially enjoying higher annual tax deductions. However, the benefits of utilizing a QCD versus taking the RMD and making a deductible contribution may vary depending on an individual’s financial circumstances. Each person’s charitable gifting strategy should consider a range of factors, including long-term goals, overall philanthropic philosophy, and desired legacy.
While this blog post has covered the essential aspects and logistical details of QCDs, it is crucial to recognize that there are numerous other considerations to explore. If you would like a thought partner to delve deeper into your specific situation and help tailor a charitable gifting strategy to your needs, I invite the conversation.