Taking Distributions from Your Retirement Account? Consider Directing Them to Charity

When you reach a certain age, you are required to take distributions from your retirement account. These “required minimum distributions” (RMDs) vary based on age, life expectancy, working status, and account balance, and those who fail to take all that they’re required will pay a hefty penalty. Unfortunately, there’s no way to skirt the RMD rules, but there is something you can do with RMD funds that you don’t need: donate them to charity.

Qualified Charitable Distributions

Qualified charitable distributions (QCDs) are charitable contributions that you make directly from your retirement account and when done correctly:

QCDs are tax-free withdrawals.

QCDs are withdrawals from your retirement account, but they won’t raise your taxable income.

You are required to report all retirement account withdrawals on your tax return, including tax-free QCDs. Total IRA distributions will be reported on Line 4a of your tax return, but on Line 4b, where the tax form asks you to report the taxable amount of your IRA withdrawals, you can exclude the amount that was donated to a charity via a QCD.

QCDs can satisfy your annual RMD.

If you are retired and are at least age 72, you will be required to take annual RMDs from your retirement account. These distributions will almost always be taxable. By forcing you to withdraw funds from your retirement account, the IRS requires you to report more taxable income, weakening the amount of control you have over your tax position.

One solution to this problem is a QCD. If you direct funds from your retirement account to a charity via a QCD, you’ll be able to satisfy your RMD without withdrawing (and being forced to pay taxes on) those funds.

QCDs effectively provide you with a charitable deduction without itemizing.

Although QCDs won’t look like a charitable deduction on your tax return, by excluding QCDs from taxable income, you are – in effect – taking a deduction for your contribution. And this “deduction” is even stronger than if you reported it as an actual charitable deduction on your return for two reasons: first, a QCD will benefit you even if you don’t itemize. And second, an income exclusion will lower your adjusted gross income (AGI), whereas an actual deduction would not. Your AGI is important because some tax credits and deductions will be based on your AGI. The lower your AGI, the more credits and deductions you could be eligible for. 

QCD Fine Print

Initiating a QCDs is quite simple, but you should follow a few rules to ensure those charitable contributions remain nontaxable.

• Your donation must go to a nonprofit organization. Most charitable organizations that the IRS has approved for nonprofit tax treatment can receive QCDs. Excluded entities are donor-advised funds, supporting organizations, and private foundations.
• Your contribution must come from the proper retirement account. If your retirement account was a qualified plan through your employer – like a 401(k), 403(b), 457(b), SIMPLE, or SEP – you could initiate a QCD from those accounts. You can also initiate QCDs from your traditional or Roth IRA. However, you typically cannot make QCDs from nonqualified retirement plans like deferred compensation plans or split-dollar life insurance plans.
• You must be old enough. You can begin making QCDs when you reach age 70 ½. However, if you initiate a charitable transfer when you’re younger than 70 ½, you’ll be taxed on the distribution.
• You must make your donation directly to the charity. The funds must be transferred directly from your retirement account to the charity. Your account custodian can help you initiate the transfer. If the check is made out to you, the withdrawal will be taxable even if you immediately donate those funds to the charitable organization.
• Only the first $100,000 will be considered a QCD. If the sum of your QCDs exceeds $100,000 in a year, the excess will be taxable to you. This is a per-person threshold, which means that if you and your spouse file jointly, you can each make QCDs of up to $100,000 per tax year.
• You can make a QCD that exceeds your RMD. QCDs are often used to fulfill a taxpayer’s RMD, but they don’t have to be used this way. You can make a qualified charitable transfer regardless of the amount of your RMD. However, if you wish for your QCD to fulfill your RMD, you will need to initiate the transfer before the end of the tax year. In addition, QCDs more than your RMD cannot roll over to offset future years’ RMDs.
• Ask for donation receipts. Request from the receiving charity a receipt for your QCD. You will need this information if you get audited.

Why QCDs are Helpful

Being required to pull funds from your retirement account can be frustrating if you don’t need the money. However, if you were free to leave your funds in your account, it could continue to grow tax-deferred. In theory, this additional tax-deferred growth could allow you to:

• Leave a more significant sum to your heirs,
• Help you save for a big future investment, or
• Have tighter control over your taxable income from year to year.

Unfortunately, there is no simple way to avoid RMDs. QCDs don’t affect the RMD requirement, but they can help alleviate the burden of paying taxes on RMDs. This is why QCDs are an essential part of tax planning for taxpayers at or near retirement age.

Contact Us

If you have any questions about the information outlined above, questions about your RMDs or would like to know more about initiating a QCD, Klatzkin can help. Click here to contact us. We look forward to speaking with you soon.

©2021 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date and does not constitute accounting, tax, or financial advice. Please consult your advisor concerning your specific situation.