Lowering Your IRA RMD Taxes

Everybody hates being told what to do, but retirement investors hate it even more when it comes with a hefty tax bill. This is why it is critical to understand the IRS rules involving required minimum withdrawals (RMDs). These mandatory withdrawals can quickly affect your retirement nest egg, especially given the potential tax liability and effect on your overall portfolio. When planning for retirement, this is what you need to know about IRA RMD taxes and how to lower your overall bill come tax time.

A financial advisor can help you find the right strategy to minimize your tax liabilities on retirement income.

How Do IRA RMDs Work?

When you have an individual retirement account (IRA), your contributions grow tax-free until the IRS requires you to begin taking RMDs. These mandatory distributions also apply to other types of tax-deductible workplace retirement plans.

RMDs must begin when you turn 72, or 70.5 if born before July 1, 1949. They were temporarily waived by the IRS for the 2020 tax year as pandemic relief, but unfortunately returned in 2021.

However, these distributions can push you into a higher tax bracket at a time when income is often diminished. An RMD can also raise your taxable income enough that your Social Security benefits become taxable and your Medicare premiums increase.

However, there is one strategy you can use to avoid RMD taxes and prevent tax liability on distributions.

Using a QCD to Lower Your RMD Taxes

One strategy to reduce RMD taxes is to utilize qualified charitable distributions (QCDs). With this, taxpayers over 70.5 years old can contribute up to $111,000 to certain charities and pay no taxes on your withdrawal.

In addition to avoiding income tax on your withdrawal, you can also stretch your donations by giving pre-tax money to your charitable causes. This can help lower future RMDs, which are reduced every year based on your life expectancy.

QCDs also allow taxpayers using the increased standard deduction to receive a charitable deduction even though they aren’t itemizing. In fact, the QCD can be better than an itemized deduction because it can reduce your adjusted gross income (AGI), serving as a basis for other tax deductions and credits.

IRS QCD Rules

The QCD maneuver is only available through IRAs and IRA-based retirement plans, such as SEP accounts and SIMPLE IRAs where the owner is no longer making contributions. You can’t make a contribution from a 401(k), 403(b) or other employer-sponsored retirement plans.

Naturally, the IRS imposes several limitations and requirements. Your QCD must come from taxable money in your IRA, excluding any contributions from after-tax rollovers or nondeductible contributions. The contribution must be made directly to the charity from your account, and the money must go to an IRS-approved 501(c)(3) charity.

Another tax wrinkle to consider is that the IRS counts the first IRA distributions in a tax year towards your RMD, so you must make QCDs early in the year if you receive IRA distributions on a quarterly or monthly schedule. If you’ve taken an RMD, you can’t go back and claim it as a QCD or offset it with a QCD contribution; only the money directly contributed counts.

Of course, you won’t need to pay any taxes on an RMD if your total taxable income remains below the IRS filing minimums, which range from $15,750 to $31,500 or more, depending on your age and filing status.

Before taking a QCD, consider discussing your withdrawal plans with a tax professional.

Who Is Eligible to Use a QCD?

To make a qualified charitable distribution, you must be at least age 70.5 at the time the distribution is made.

This age threshold is fixed and does not change based on newer RMD starting ages. Even if your RMDs do not begin until a later age, you still cannot use a QCD unless you have already reached 70½.

QCDs can only be made from certain types of retirement accounts. Traditional IRAs are eligible, as are SEP IRAs and SIMPLE IRAs if the account owner is no longer making contributions. Employer-sponsored plans, such as 401(k)s, 403(b)s and 457(b)s, do not allow QCDs directly.

Roth IRAs can technically be used for QCDs, but they often provide little or no tax benefit. Because qualified Roth IRA distributions are already tax-free, using a Roth account for a QCD does not usually reduce taxable income in the same way a traditional IRA distribution would.

There is an annual limit on how much you can contribute through QCDs. Individuals can direct up to $111,000 per year from their IRA to qualifying charities. Married couples can each make their own QCDs up to the annual limit from their respective IRAs.

Not all charities qualify to receive QCDs. The recipient must be an IRS-approved 501(c)(3) public charity. Donor-advised funds, private foundations and supporting organizations generally do not qualify, even though they may accept tax-deductible donations in other contexts.

Finally, the distribution must be made directly from the IRA to the charity. If the funds pass through your personal bank account first, the transaction will not qualify as a QCD and will be treated as a taxable distribution. Following this direct-transfer rule is necessary for the exclusion to apply.

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Bottom Line

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Making a qualified charitable distribution, or QCD, from an IRA to a qualifying charity is one way to lower your tax bill. This is even more impactful than a direct tax-deductible contribution because you don’t get credit for a charitable donation if you don’t itemize your deductions.

Be sure to note your QCD on your income tax return. Simply add the amount you donated to the total amount of IRA distributions you took. If all of your distributions were QCDs, you can indicate that the taxable amount is zero and enter “QCD.”

A financial advisor can help you create a retirement strategy that maximizes your tax deductions.

Tax Tips

A financial advisor can help you with your tax issues. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Filing your taxes each year can be a pain, but it helps to know what you might be looking at in terms of a return before you actually go to file.To see what your tax return might look like, use SmartAsset’s free tax return calculator.