Supporting charitable organizations is a lifelong habit for many people. But once you get into retirement, there may be additional tax benefits you can take advantage of if you use a qualified charitable distribution (QCD) instead of donating by check. A QCD is a donation from your IRA account directly to the charity you’d like to support.
If you take the standard deduction on your tax return, you don’t get the tax benefit for the gift the way you would if you itemized your deductions. The QCD remedies that. Because it is excluded from your income, it reduces your taxes.
Other benefits include providing you with more flexibility when it comes to avoiding or minimizing taxes on Social Security or the Medicare IRMAA surcharge because it counts against your required minimum deductions for the year, which helps to reduce income.
There are some essential things to know but creating a strategy that shifts your charitable giving to your IRA accounts can be an intelligent way to make a long-term impact and maximize your giving.
The ABCs of QCDs
First up, you need to be 70 ½ before using the QCD.
If you have a tax-deferred retirement account that has required minimum distributions beginning at age 72, you can make a (QCD) of up to $100,000 per year directly to a qualified charity of your choice. The $100,000 limit is on the individual, not the account. If you have multiple accounts, you can take a combined total of $100,000 from all accounts.
The charity must be a qualified 501(c) 3 organization. The QCD check must be paid directly to the charity. Many custodians are familiar with the process and even provide checks that can be used for QCDs directly from the account.
If you’ve set up a donor-advised fund (DAF) for your giving strategies, you cannot use a QCD for donations to your DAF. Donations of appreciated securities are a better choice for a DAF.
You Don’t Have to Itemize to Get the Benefit
The simplification of the tax code and the increase of the standard deduction freed many people up from the annual chore of itemizing deductions. You don’t have to return to those tedious days with the QCD. You can still take the standard deduction because the QCD isn’t a tax deduction. Converting your required minimum distribution (or a portion of it) into non-taxable income lowers your AGI and your tax bill.
Let’s Take a Closer Look at the Tax Benefits
The QCD reduces your adjusted gross income (AGI). A lower AGI means a lower tax bill. Even though you may pay a low tax rate in retirement, lowering your overall taxes and lowering your income can be very important. Up to 85% of your social security benefits are taxable. Additionally, Medicare Parts B and D carry a surcharge based on your income. It’s called the Income Related Monthly Adjustment Amount (IRMAA), and it’s essentially a means test for Medicare benefits. A lower AGI due to a QCD can result in not only lower taxes due to the QCD being excluded but can potentially reduce taxes on your social security benefits and the IRMAA surcharge.
The IRMAA is tiered according to different income levels, and it can be a hefty addition to your Medicare bill. Missing the cut-off by hundreds can mean paying thousands extra in premiums. Reducing your RMDs with a QCD could keep you in a lower tier.
The IRMAA has a two-year look back on income, so you’ll need to be mindful of other sources of income as well. If you have a year in which your income may be larger than usual due to an asset sale or additional large income inflow, a QCD gifting strategy to lower your income can help you avoid the IRMAA down the road.
You may also get a tax break on your state taxes depending on your state. State taxes often use the Federal AGI as the starting point for calculating your state tax liability, so the reduction in AGI will carry over to the state tax bill, too.
The Impact on Your Giving Strategy
Using a qualified charitable distribution may allow you to donate more, while preserving the tax benefits. There are limits on how much of a charitable donation is deductible. These are based on AGI and are usually 20%-60% of AGI. These limits do not apply to QCDs.
The Bottom Line
Using a qualified charitable distribution as a part of your giving strategy can help you lower taxes, control income, and potentially reduce the impact of higher income on social security and Medicare. However, it’s essential to understand your likely income stream and factor in your charitable giving plans before you decide.