If you are over age 70 ½ and are taking required minimum distributions (RMDs) from an IRA, giving to charity directly from the IRA is a good way to go for a variety of reasons. You can direct any portion of your distribution to be contributed directly to one or more charity–this is called a qualified charitable distribution or QCD. Such contributions would not be deductible, but the IRA QCD withdrawal would not be taxable for federal tax purposes.
This method would particularly benefit people who do not itemize or who would otherwise get no tax benefit from their charitable payment…those with low income where the IRA distribution would trigger a tax on Social Security benefits…or those in higher federal tax brackets who will not get a full benefit for their contributions.
Making a qualified charitable distribution would also reduce adjusted gross income, possibly benefiting Medicare premium payers and those in the highest tax brackets.
But (no shocker) there are caveats and rules that must be followed to get the best financial outcome not only for the charity but for you as well. Here are some of the rules (with thanks to my partner Brian Lovett, CPA, JD, who helped lay these out)…
- There is a maximum transfer under this method of $100,000 per year per taxpayer. Spouses can each make qualified charitable distributions of $100,000.
- The taxpayer must be over age 70 ½.
- QCDs can come only from traditional IRA accounts; they cannot come from an active SEP, SIMPLE, Roth IRA, 401(k) or 403(b) plan or any other type of pension or retirement plan. A QCD can be made from a completely inactive SEP, but I would check first with an advisor before doing that.
- The QCD must be paid directly to the charity by the IRA custodian.
- The charity must provide a contribution acknowledgement the same as for direct-from-taxpayer contributions.
- If you have a 401(k), 403(b) or other type of retirement plan that RMDs must be taken from and you want to make a QCD, one possibility is to roll the account over to an IRA and then make the QCD. Caution: There are other things to take into account when considering rolling over a 401(k) or other retirement plan to an IRA. For instance, a participant over 70 ½ who is still working and is not more than a 5% owner of the company sponsoring the retirement plan does not have to start RMDs…there are ERISA liability and bankruptcy protections for a qualified retirement plan that might be better for the participant than IRA protections…rolling over a retirement plan needs spousal consent under certain circumstances…if beneficiary designations differ between the accounts, the rollover would change them. Also, the retirement plan investments might be managed while the IRA would not be, and an investment advisor might then need to be engaged. Taxes are important, but how you manage your wealth and who you designate it to go to might be more important and would affect a greater portion of the net assets. Do not let taxes drive the cart.
- The QCD might be taxable as a retirement account distribution for state You would have to check your state’s income tax rules.
- QCDs cannot be made to a donor-advised fund or private foundation; only directly to a public charitable organization.
- If the IRA includes nondeductible contributions, a special rule permits QCDs to be treated as coming fully from deductible funds without having to allocate the distribution between deductible and nondeductible contributions, as would be done if the RMD were made directly to the participant.
- If a QCD is made that includes nondeductible funds, there would be a charitable tax deduction to the extent of the nondeductible distribution if the taxpayer itemizes.
This, as with all potentially powerful but complex tax moves, should be discussed first with a knowledgeable tax advisor who will not only advise you on the tax issues but who will also consider the applicability to your entire financial plan.
For more information, check out Edward Mendlowitz’s website, or click here to purchase his book, Managing Your Tax Season.