When you were younger and busy building your nest egg, chances are you didn’t give much thought to the impact Required Minimum Distributions (RMDs) might have on your retirement one day.
The plan back then, when you chose to put your savings into a traditional IRA, was probably simple: take advantage of the tax benefits of the account every year for many years while accumulating as much money as possible.
Someone may have mentioned something about the IRS eventually getting a cut of that money when you hit your early 70s, but that problem seemed a long way off. Now, there you are, and those RMDs are looming. And because of your diligent saving and smart investing, the tax bite — starting at age 72 and continuing every year thereafter — could be staggering.
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Fortunately, if charitable giving is part of your retirement goals, there is a tax relief strategy that can benefit you and your favorite charities. This is called a Qualified Charitable Distribution, or QCD.
Once you reach age 70½, the QCD rule allows you to instruct your IRA administrator to transfer up to $100,000 per year to one or more 501(c)(3) charities eligible. And because that money goes directly to charity, it’s not considered taxable income and you won’t pay tax on the amount you donate.
A charitable tax deduction without detailing
The ability to make this charitable tax deduction without itemizing can be a significant benefit in itself. If the higher standard deduction that was put in place in 2018 turned the breakdown into a ban for you, you can use a QCD of 70½ to maintain your charitable donations while still getting tax relief.
But if you’re 72 or older and need to take RMDs, the benefits are even better. The QCD amount can then be counted towards your RMD for the year. Instead of paying taxes on the mandatory withdrawal as ordinary income – as an RMD normally works – you shouldn’t pay taxes on the part of your RMD that you donated to charity.
Using your RMD as a charitable contribution excludes that amount from your Adjusted Gross Income (AGI). This means that in addition to reducing your income taxes, it could also reduce the amount of your Social Security benefit subject to federal income tax and help you avoid or reduce Medicare income-related surcharges.
We’re talking about potential tax savings here, so of course there are rules and limits. Here are some things to consider:
You cannot make a QCD from an employer-sponsored plan. If you have savings in a 401(k), 403(b), deferred compensation, or a Thrift Savings Plan (TSP), you cannot make a QCD directly to a charity. However, you can directly transfer money from this type of plan to a traditional IRA and then perform the QCD from the IRA.
You cannot receive any benefit for doing a QCD to a charity. So, for example, you could not pay the entry fee for a charity tennis tournament with the QCD gift or buy something at a charity auction. (If you have any questions about what’s acceptable or not, it’s a good idea to consult your financial or tax advisor.)
You can split the QCD between multiple charities or donate to just one. But the money should only go to qualifying charities. (The IRS offers a search tool for tax-exempt organizations (opens in a new tab) on its website.)
You and your spouse can use a QCD. If you and your spouse are 70½ or older and each have their own IRA, you can both take advantage of a QCD and give up to $100,000 each.
Your QCD amount may be higher than your RMD. If you donate more, however, you cannot carry the excess forward to future tax years. (You can also donate less than your full RMD, but if you do, you’ll still have to withdraw the remaining RMD amount and pay regular federal taxes on it.)
Last but not least (and these two are biggies):
You cannot transfer funds from your IRA to your personal account and then write a check from your account to your charity. The money must be paid directly from the IRA to an IRS-approved charity.
If you work with a tax preparer or accountant, be sure to let that person know that you performed a QCD. You should receive a 1099 indicating that the distribution has taken place, but the form may not clearly identify the distribution as QCD. If the distribution is not correctly recorded on your tax return, you could lose your tax relief.
The rules (and the risk of being wrong) can make using QCDs off-putting at first. And it might not be a DIY move – at least not the first time you do it. But the benefits for you and your favorite charities are worth checking out what this strategy has to offer. Your financial advisor or tax advisor can explain the pros and cons and how they may apply to your particular situation.
Kim Franke-Folstad contributed to this article.
Appearances on Kiplinger.com were obtained through a paid public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Investment advisory services made available by AE Wealth Management, LLC (AEWM). AEWM and Scott Tucker Solutions, Inc. are not affiliated companies.
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