The Win-Win Strategy: QCDs and Charitable Contributions
What is a Qualified Charitable Distribution?
A Qualified Charitable Distribution (QCD) is a direct transfer of money from an Individual Retirement Account (IRA) to a qualified charitable organization. QCDs have gained popularity in recent years due to their unique advantages for both retirees and philanthropic causes. Unlike traditional withdrawals from an IRA, QCDs allow individuals aged 70½ or older to donate a portion of their Required Minimum Distributions (RMDs) directly to a qualified charity, bypassing taxable income.
Qualified Charitable Distributions (QCDs) offer a unique opportunity to impact charitable causes while optimizing your retirement savings positively. By leveraging QCDs, you can enjoy tax benefits, fulfill your RMD requirements, and support the organizations and causes you care about most.
Let’s look at an example. Assume you want to donate $1,000 net of taxes to a charity you support and are subject to 20% total taxes. If you wanted to fund that donation from your IRA, you have two options:
Regular Option: Distribute money to your bank account, then send the $1,000 to the charity via check or ACH. However, since you are taking a normal distribution, you must pay taxes on the distribution. You decide to withdraw $1,200 from the IRA and withhold $200 for taxes.
QCD Option: Alternatively, you are eligible to make Qualified Charitable Distributions. Since QCDs are not subject to taxation, you no longer need to withhold the $200 in taxes. Rather than sending the money to your bank and then to the charity, you instruct your IRA custodian to send the $1,000 donation directly to the charity completing the QCD.
Benefits of a Qualified Charitable Distribution
Why do a Qualified Charitable Distribution? Qualified Charitable Distributions (QCDs) have four primary benefits:
- QCDs reduce your income and save on taxes. Without QCDs, charitable donations can be deducted through itemization of deduction. The increase in the standard deduction due to the 2017 Tax Cuts and Jobs Act means most Americans do not itemize their charitable donations. Since the standard deduction is higher than their itemized deductions, the tax benefit to charitable donations is not realized. However, QCD effectively allows those taxpayers to continue to benefit from charitable donations by reducing their income without itemizing deductions.
- QCDs satisfy Required Minimum Distributions (RMDs). At certain ages, the IRS requires you to begin taking distributions from your pre-tax retirement accounts (401k’s, Traditional IRA, Simple IRA, etc.) whether you need the money or not. The purpose of this forced distribution is to finally collect tax revenue on the money you deferred into the account. However, QCDs allow you to send the money to a charity and not be taxed on the distribution you would have otherwise have to take.
- QCDs lower your Adjusted Gross Income (AGI). AGI is an important figure in taxation as it is the basis for a slew of other calculations that impact Medicare and Healthcare Premiums, Contribution Limits, Credits, and more. Performing a QCD eliminates the income from the distribution from appearing on your tax return in the first place and thereby does not increase your AGI.
- QCDs increase your giving capabilities. Because you are not being taxed on the money sent to charities through a QCD, you are increasing your ability to give to the charity by the amount you would normally have to send to charity. For example, in the above examples, you could increase your charitable donations from $1,000 to $1,200 and still be in the same financial position as the example without QCDs.
Who can do a Qualified Charitable Distribution
You must be age 70 1/2 or older to be eligible for a QCD.
The QCD must be made to a qualified 501(c)(3) organization. There are additional restrictions identified below.
The QCD can only be made from a Traditional IRA, Inherited IRA, SIMPLE IRA, or SEP IRA.
Limits to the Qualified Charitable Distribution
The QCD Limit: QCD’s are limited to a specific dollar amount each year. While this may apply to some very wealthy people, most donate well below this limit each year. See Latest Tax Resources – Gilbert Wealth for the current limit
Limited Organizations: You cannot use a QCD to give money to individuals, Private Foundations, Donor Advised Funds, or Supporting Organizations.
Cannot Itemize: You cannot itemize QCD’s as this would be double dipping on the benefit.
How to make a Qualified Charitable Distribution
- Identify the eligible organization and obtain address information.
- Determine the amount you would like to donate
- Request the transfer from the custodian. The distribution can be one time or regularly such as monthly, quarterly, or annually.
How a QCD is Reported for Taxes
While QCD’s are perfectly legal and in the IRS code, there does not yet exist a specific code that shows a distribution was a QCD. Because of this, any QCD you make is reported as a normal distribution on IRS form 1099-R. It is up to you, or if you work with a good financial advisor, to communicate with your tax preparer that you made the distribution. You must then account for the QCD appropriately on the IRS Form 1040 to ensure that you are not taxed on the Qualified Charitable Distribution.
On the tax return, a QCD typically shows up as follows:
This picture is for educational purposes only and does not constitute tax advice. Please see your tax accountant for specific information surrounding your unique situation.