Here’s a win-win: Direct some of the income from your required minimum distributions (RMDs) to charity. The charity wins by receiving your contribution, and so do you, because you’ve lowered your adjusted gross income.
Here’s everything you need to know about using the qualified charitable distribution (QCD) to reduce your taxes by lowering your adjusted gross income (AGI).
If you have tax-deferred retirement accounts, and you’re older than 72 (or if you were 70.5 before December 31, 2019, thanks to the SECURE Act), then you’re required to distribute (or withdraw) a certain amount of funds from your accounts each year. RMDs apply to traditional IRAs, SEP IRAs, 401ks, and some other defined contribution retirement plans.
One challenge with RMDs is that those distributions can increase your income, and thereby the amount of income tax you must pay. But if you have RMDs from a traditional IRA, you can offset that increase with QCDs.
What are QCDs?
QCDs are one strategy for potentially decreasing your overall tax burden. They involve directing your IRA distributions in a given tax year to an eligible charitable organization, rather than distributing the funds to you.
Who might want to use a QCD?
If you are required to take RMDs, but you don’t need the funds, then this could be a good option for you. Early in the year is a good time to plan your charitable contributions and to consider with your tax advisor if this would be a good strategy for you.
What are the QCD rules?
QCDs are not tax deductible. However, any funds you direct in this way will be excluded from your taxable income, which is not necessarily the case if you were to receive the funds first, then use them to make a charitable contribution. This is because an itemized deduction just lowers your taxable income, not your AGI.
The charity must be IRS-approved. Approved charities include 501(c)(3) organizations and houses of worship. You can see a searchable list on the IRS website. Donor-advised funds, supporting organizations, or private foundations aren’t eligible.
There’s a maximum dollar amount. You can distribute funds as a QCD up to $100,000 per IRA. If you’re married and each spouse is an IRA owner, you can each distribute $100,000 from your respective IRAs.
Funds must be transferred directly to the charity. For a QCD to count toward your RMDs, it must be distributed from your IRA to the eligible charitable organization.
You must be at least 70 ½ years of age. Even if you don’t have to begin taking RMDs until you’re 72, you can begin making QCDs at age 70 ½.
QCDs must be reported on your tax return. Your IRA custodian will report your QCD as a normal distribution on IRS Form 1099-R. In the case of an inherited IRA, it will be reported as a death distribution. You will report QCDs on your Form 1040 on the same line where you enter IRA distributions.
Roth IRA distributions won’t help you with the tax advantage. While technically you can make QCDs from a Roth, you’ve already paid taxes on that money, so doing so isn’t a beneficial tax move.
Distributions must be made by December 31. Just like an RMD must come out of your IRA by December 31, the same goes for QCDs if you want to count them towards RMDs.
Have questions about QCDs or other tax strategies you can use in retirement? We’re here to help set you up for complete financial success. Contact Ironwood Wealth Management today.