Americans donate seven times more than their European counterparts. Charitable contributions actually increased in 2020—during a global pandemic—to $417 billion, with donations coming from every demographic and income level. It’s safe to say that charitable giving is part of our cultural and personal ethos.
Since giving to charity is so integral to our budgets, it’s wise to look for ways to ensure your donations are financially beneficial and increase the overall value of your gift. One such option is fairly new and was made a permanent tax rule in 2015: qualified charitable distributions (QCDs).
Key Takeaways:
- QCDs are charitable donations made directly from an IRA to a qualified 501(c)(3) charity.
- Retirees can use QCDs to support their preferred charities and lower their personal tax liability.
- Don’t forget to weigh the effects QCDs can have on other distributions and premiums affected by your taxable income.
What Is A QCD?
Qualified charitable distributions are specifically designed to benefit retirees beginning at age 70.5 who want to better manage their income and tax bracket while also supporting meaningful causes and organizations.
With a QCD, you can enable your IRA custodian to transfer a set amount of money directly from your account to the qualified charity of your choice. Many retirees implement this strategy as a way to satisfy their annual required minimum distributions, which begin when they turn 72. That way, the money doesn’t count toward their taxable income, and they can give to meaningful causes.
For retirees toeing the line between tax brackets, QCDs can undoubtedly be effective.
But you can’t give money to just anyone; the type of charity you donate to matters. The “qualified” part of the acronym refers to all charities registered as a 501(c)(3) tax-exempt organizations with the IRS.
You can see if your favorite charity made the list by searching for organizations that have been granted tax-exempt status. The list includes religious organizations, philanthropic groups, and nonprofits for hundreds of goodwill causes.
Unfortunately, private foundations and donor-advised funds don’t qualify.
There is an annual $100,000 QCD limit per individual. If you’re married, your spouse can also donate up to $100,000. QCDs are limited to the amount that would typically be taxed as ordinary income, excluding non-deductible income such as withdrawals from a Roth account. In other words, you can’t exceed your taxable income and underrepresent how much you’re bringing in.
If you decide to receive your RMD first, you’ll need to pay income tax and then itemize the donation as a tax deduction. It’s essential that you set up the QCD with your account custodian for your gift to be classified as such.
How Retirees Can Utilize QCDs
As a retiree, one of your biggest financial chores will be managing your income and taxes. Once you start taking RMDs from your tax-advantaged accounts, it becomes taxable income and could bump you to the next tax bracket. Paying unplanned taxes can be risky or frustrating on a fixed income.
QCDs allow you to donate all or a portion of your RMD before it becomes taxable, giving it double the power. You won’t need to pay taxes or a potentially higher tax rate, and the charity will receive more than if you cashed out, paid taxes, and then donated.
If charitable giving is a permanent line item in your annual budget, why not magnify the value and impact for you and your charity?
Other Tax Implications
On your tax return, a QCD would be listed as a distribution, meaning you can’t also list it as a tax deduction for a charitable gift. If you usually itemize your deductions and gifts to get the most tax benefit, you may have to adjust your deduction strategy.
In 2018, the Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction while limiting the number and types of itemized deductions, making standard deductions more beneficial and common.
QCDs reduce your taxes by reducing your taxable income. Remember, your taxable income or modified adjusted gross income (MAGI) affects many of your retirement benefits. Here are just a few examples and lots of charts to reference.
- Medicare Premiums. Social Security uses your MAGI from two years prior to determine your monthly premiums for Part B and D and whether you qualify for an additional surcharge, known as an income-related modified adjustment amount (IRMAA). For example, your 2023 Medicare premiums and IRMAA are determined by your 2021 MAGI.
Use the chart below to see how much your premium and IRMAA can change between income thresholds.
- Taxable Social Security Benefits. Social Security also uses your MAGI to calculate whether you owe taxes on your social security benefits. If you do owe taxes, you’ll only need up pay them on up to 85% of your benefits.
Source: IRS
- Net Investment Income Tax (NIIT). This is a flat rate tax on your income from investments based on your MAGI. For 2022, the tax rate is 3.8%.
Taxable net investment income includes short- and long-term capital gains, dividends, taxable interest, royalties, rental income, and passive income from investments.
These are just a few areas where MAGI is used to calculate your taxes. It’s also used as a threshold for various credits and deductions. In short, MAGI is a big deal, and any strategies used to modify it should be done carefully and with every implication in mind.
Create A Strategic Giving Plan
There are many ways to purposefully give to charity, like setting up donor-advised funds or tax-deductible charitable gifts. You can even bundle your charitable gifts by donating two years’ worth of funds in one year to maximize your tax benefit.
Of course, once you hit the RMD age of 72, QCDs should be on your list for managing your taxable income, meeting your retirement goals, and continuing to donate to the charities that mean the most to you.
To find the best strategy that benefits your finances and preferred charity, schedule a free consultation with us today. We’ll help you wade through your tax implications and create a plan that magnifies the impact of your charitable gifts.
