How to Use Qualified Charitable Distributions to Reduce RMDs
Qualified Charitable Distributions can be a very handy way to satisfy one’s annual RMD requirement while also supporting charitable causes. By using a QCD, IRA owners reduce their annual RMD by the same amount as the QCD.
A few years ago I was listening to yet another financial podcast when the hosts began explaining how charitably minded individuals could reduce or avoid required minimum distributions (RMDs) through charitable giving.
My parents and one of my in-laws had just reached age 72 and they were all owners of IRA accounts. Thus, they were all staring RMDs right in the face.
I also knew that they didn’t necessarily need at least some of the income the RMDs would produce. As a result, they would have to pull funds from their IRAs that they didn’t need and end up paying additional taxes they didn’t want to pay.
I don’t know exactly how many people do or don’t actually need their RMDs to live on, but according to Ameriprise Financial, 68% of people who own IRAs only take the RMD. This would imply that most people don’t need all or perhaps any of it.
As it so happens, I also knew that my parents and in-laws were givers. As I listened on to the podcast, I learned about a strategy that would allow them to combine their giving with their RMDs, resulting in an overall reduction in their annual tax liability.
We’ve recently discussed reducing one’s RMD liability through Roth IRA Conversions. In this post, we’ll discuss how you can reduce or eliminate your annual RMD altogether through Qualified Charitable Contributions or QCDs.
Qualified Charitable Distributions
A qualified charitable distribution (QCD) is a strategy for redirecting annual required minimum distributions (RMDs) to a charity of your choice instead of receiving the RMD as income for yourself.
Once you reach age 72 (or 73 or 75 depending on when you read this), the IRS requires that you begin taking an income in the form of an RMD from tax-deferred retirement accounts.
As we’ve already pointed out, in many cases, retirees find that they no longer need the money in these tax-deferred vehicles and would prefer to allow the balances to grow instead of incurring income taxes for withdrawals.
So, RMDs basically force their hand.
The RMD amount is calculated using a formula provided by the IRS which is designed to slowly force account owners to pay taxes on the money that has been building for years (about 4% the first year).
Fail to take an RMD and you’ll pay a 50% penalty* on the undistributed amount.
No. They’re not messing around.
However, if you are charitably inclined, QCDs allow a direct donation to be made to a qualified charity. In exchange, you can reduce your RMD by the amount you’ve given away.
Since the funds are coming out of a tax-deferred account (meaning they’ve never been taxed) you don’t get a deduction, but you never have to pay any tax on the sum.
In summary, by making your gift through a QCD, your charity is relieving you from incurring the tax liability for withdrawing that same amount in RMDs.
(*Again, unless you’re reading this after 2023. The rules are changing to 25% or maybe 10% if you beg.)
For the Cynics…
“But, Curt, Couldn’t I claim a deduction if I just took the RMD, then wrote a check to the charity?”
Great question. Yes, you could still get a deduction, but you’ll have a higher MAGI as a result.
This could also potentially put you into a higher tax bracket, reduce your options for conversions, impact taxes on social security, and even increase your Medicare surtax.
Let’s look at an example, shall we?
Fiona Philanthroper
Fiona is 72 and must begin taking RMDs this tax year. Fiona’s employer provided a pension for her retirement and she just started receiving social security a couple of years ago.
Together, both of these income sources are more than enough to cover her living expenses.
Fiona does not need to withdraw any income from her IRA to live on.
As it so happens, Fiona was listening to the same podcast I was, where we both learned about QCDs. After the podcast, Fiona is super-excited.
Why? Because she realizes that she can simply redirect her RMD to her favorite charity, Make-A-Wish, and satisfy her RMD requirements for the year while continuing to support a great cause.
In the end, she’ll have more cash in her checking account since she won’t be sending money directly to the charity, but she won’t have to realize any income from her IRA triggering a higher tax bill next April.
Other important points:
- The QCD must go directly from your account custodian to the charity. If it comes through you, you will owe income tax for the distribution.
- Currently, you are limited to $100,000 in QCDs per tax year.
- You can begin QCDs at age 70.5 even though RMDs don’t start until age 72. The primary reasons to do this would be to reduce RMDs that you would incur later or lower the amount you have to convert to Roth IRAs if you are utilizing a conversion strategy.
- Your RMD amount is calculated using your IRA balance from the end of the previous year. The IRS has tables corresponding to your age so you know what percentage to withdraw.
- To count toward your RMD the QCD funds must leave your account by December 31 of the same year as the RMD.
- You cannot make a QCD from a 401k, but odds are you’ll have long since rolled yours over to an IRA. (This may change too with SECURE 2.0.)
- You can donate a portion of your RMD as a QCD, but the remainder must be withdrawn before the end of the year.
FAQs
Can I have my IRA custodian send the check to me?
Nope. If you touch it then you’ve blown up your QCD. Sorry.
Are there any QCD limitations?
Currently, you can only make a QCD in the amount of $100,000 per person. Effectively, this means couples in which both spouses have an IRA can combine forces to make really, really large QCDs.
How old do I have to be to make a QCD?
Oddly enough, you can begin making QCDs at age 70.5 even though RMDs don’t begin until 72. I’m sure there’s a reason for this, but I didn’t look it up.
How do I calculate my RMD?
See the table in this post
When are RMDs calculated?
IRA balances at the close of the year (midnight on 12/31) are used as the basis for calculating RMDs and the deadline for receiving credit for QCDs. Don’t wait until Christmas to make your QCD. You’ll have had the opportunity to know your RMD amount since 1/1, so procrastinating doesn’t really help anything.
