Charitable giving is an important component of many people’s lives. The 2018 Tax Cuts and Jobs Act changed the way many people approach their giving strategy. With the standard deduction doubling to $12,000 for single filers and $24,000 for married filers, many families were unable to itemize their deductions, leaving avid donors looking for a new way to give to charity in a tax-efficient way.
Retirees have an opportunity that other people don’t, donating their required minimum distributions (RMDs) to charity through a process called a Qualified Charitable Distribution (QCD).
What are QCDs and how can they impact your giving strategy? Let’s find out.
What are QCDs?
A Qualified Charitable Distribution is a tax-efficient process of donating assets from an IRA to a qualified public charity. This strategy allows retirees to manage their required minimum distributions and use some or all of the money for their charitable efforts. Donating through a QCD is tax-free which increases your gift and lessens your tax burden. Reducing your taxable income can lead to many credits and tax deductions and is important for retirees to be proactive about.
RMDs are mandated withdraws from applicable tax-deferred accounts (traditional IRA, 401k). They begin when the account owner turns 70 ½ and are in place for the remainder of the owner’s life. RMDs are an important piece of a retiree’s annual financial strategy, as forgetting to take them or failing to take enough money out triggers a 50% penalty. Since you didn’t have to pay taxes on your contributions to these accounts, all of the distributions are taxed at your regular income rate, leaving many people searching for a more tax-efficient strategy.
While many retirees need some of their RMDs for living expenses, you do have the option of using some of your RMD for charitable purposes. Let’s say your annual RMD is $8,000 and you want to keep $5,000 for living expenses and donate the $3,000 to a charity through a QCD. You will need to pay ordinary income tax on the $5,000 for personal use but wouldn’t need to pay tax on the donated $3,000.
If you are using a QCD in place of your RMD and you withdraw more than you need to, those funds will not roll over into next year. Each year has its own, independent RMD.
How do QCDs work?
As with many systems and processes, QCDs have a few stipulations to operate correctly. The most important one is that a QCD can only be made through a traditional IRA.
For both you and the charity to receive the benefits of this strategy, the transfer of funds has to come directly from the IRA custodian to the qualifying charity. Should you withdraw the funds on your own and donate after the fact, you will be taxed on the withdrawal and the process becomes null. Normally the IRA custodian will transfer the funds directly to the charity, but sometimes they will send you a check. If that happens, all you need to do is give the check directly to the charity.
You’ve probably noted that this article mentions “qualifying” charities a lot. Are there some charities that don’t qualify for a QCD? The answer is yes. The charity of your choice needs to be a 501(c) (3) and able to receive tax-deductible contributions. There are three types of charities that don’t have that status:
- Private foundations
- Donor-advised funds
- Supporting organizations
Take some time to ensure that the charity of your choice meets the requirements before starting the process.
It is also important to note that you aren’t able to itemize your QCD on your taxes. Simply ensure that the QCD is clearly marked on your 1040. Your 1099 will not make mention of your QCD. It is your responsibility to tell your tax preparer the amount of the IRA distributions that are QCDs. Check with your financial planner and tax professional to make sure you have all of the necessary documents.
Your financial planner can help
Charitable giving doesn’t have to slow down in retirement, it can just take on a new look. Donating by using QCDs is an excellent strategy for retirees to propel their charitable efforts while also being tax-savvy.