An individual retirement account owner aged 70 ½ or more may be able to withdraw money from the account tax-free and use it to support favorite causes with a qualified charitable distribution (QCD). However, a number of rules govern QCDs, including age requirements and restrictions on the types of retirement accounts.
A financial advisor can help you find ways to tax-efficiently support favorite causes.
Understanding Qualified Charitable Distributions
Withdrawals from individual retirement accounts typically are subject to federal income taxes. This includes required minimum distributions (RMDs) that retirees must start withdrawing from their retirement accounts once they reach age 73. However, IRA account holders can withdraw funds including RMDs without incurring any income tax liability using a qualified charitable deduction (QCD).
Choosing QCDs might prove to be more beneficial than making standard charitable contributions, especially for those who don’t itemize their deductions. By reducing taxable income, QCDs can also reduce Social Security taxes and potentially help avoid the 3.80% Medicare surtax on investment income. This is a tax applicable to individuals with income surpassing a certain threshold.
The key to getting this tax benefit is that the QCD funds must be withdrawn with the intention of directly donating them to a recognized charity. In addition to this essential requirement, a number of additional restrictions control the use of QCDs, including age and type of retirement accounts.
Criteria for Making a QCD
Age is a key criterion for making a QCD. To use a QCD, the IRA holder should be at least 70½ years old at the time of the distribution.
Account type is another restriction. QCDs generally can only be made from traditional IRAs and inherited IRAs. They can’t be made from a SIMPLE IRA or SEP IRA unless at the time of the distribution the accounts are inactive, meaning neither the taxpayer nor the employer has made a contribution during that calendar year. Roth IRAs typically aren’t ideal for QCDs because withdrawals from Roth accounts are already not taxed.
The money also has to be going to an appropriate charity. Only recognized charities that accept tax-deductible contributions, like 501(c)(3) organizations, can receive QCDs.
In addition, there are limits on the dollar amount of QCDs that a taxpayer can take. Each year, an individual taxpayer can donate up to $100,000 using QCDs. For married couples filing jointly, the limit is doubled to $200,000.
Finally, the funds can’t take any detours on the way. Money should go straight from the IRA to the charity. Indirect transfers don’t count as QCDs.
Despite these restrictions, QCDs offer considerable flexibility for the charitable-minded. While the dollar amount is limited, the number of QCDs is not capped. That means, someone can contribute to multiple charities in the same year by using different QCDs.
QCD Reporting
QCDs also call for some special treatment when filling out a tax return. Taxpayers need to report the QCD on Form 1040, mentioning the full charitable distribution amount. On that form, they’ll indicate the taxable amount was zero if the full distribution was a QCD. Next to this line, they’ll write “QCD.”
As is the case with most tax-related documents, it’s a good idea to get and hang onto the receipt for the donation. It could come in handy in case a question arises about the QCD.
QCD Example
To give an example of how all this might work, consider a retiree past age 70 ½ with an annual RMD of $20,000 from a traditional IRA. Rather than taking the full RMD distribution, they decide to donate $15,000 to a favorite charity using a QCD.
By doing this, they fulfill a portion of the RMD so that they will only owe income tax on $5,000 instead of $20,000. Of course, they will not have the $15,000 that they would otherwise have, after paying taxes on it, to spend elsewhere. They would get non-financial compensation from the satisfaction of knowing their money is going toward a cause they care about.
Bottom Line
For seniors with IRAs, a QCD offers an avenue to make the most of their funds both philanthropically and financially. QCDs let people past age 70 ½ withdraw from IRAs without increasing their taxable income as long as the money is going directly to a qualified charity. This can be especially useful for people who have to make RMD withdrawals that can increase their taxable income.
Tax Planning Tips
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A QCD is just one of many ways you can support favorite causes while getting advantageous tax treatment. A financial advisor can help you evaluate other options for keeping a lid on taxable income. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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SmartAsset’s Tax Return Calculator will help you estimate your federal income tax refund or amount owed based on your income, withholdings, deductions and credits.
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