Giving to charity can be a benefit in many ways. Not only does it help people and make you feel good, it can have a positive impact on your taxes. Taking money out of an individual retirement account (IRA) to give to charity is known as a qualified charitable distribution (QCD), and it may help you with your taxes. Make sure you know everything about QCDs before making the decision to take this path, and talk to a financial advisor if you need help. Find a financial advisor with SmartAsset’s free financial advisor matching service.
What Are Qualified Charitable Distributions (QCDs)?
A QCD is the withdrawal of funds from an IRA with the intention of donating them directly to a qualified charity. There are tax benefits that go along with this strategy. You can use QCDs when you’re taking required minimum distributions (RMDs) in retirement.
You may qualify for a QCD if you have a traditional IRA, an inactive SIMPLE IRA (meaning you and your employer are no longer contributing to the account during the same tax year that you’re making a charitable contribution), an inactive SEP-IRA or an inherited IRA. However, certain rules apply.
Making qualified charitable distributions from Roth IRAs is usually a bad idea (and it’s usually prohibited). Why? For one thing, a QCD must be a distribution that would normally be subject to taxation. Roth IRA distributions are usually tax-free.
Your Roth IRA may be eligible for a QCD if you’re willing to pay taxes on your withdrawals. But if you wouldn’t otherwise owe the IRS money, agreeing to pay taxes on Roth IRA distributions doesn’t make sense.
Rules for Making Qualified Charitable Distributions (QCDs)
You can’t qualify for QCDs unless you can meet certain requirements. For example, you can’t make a qualified charitable distribution unless you’re at least 70 1/2 years old. You can make QCDs to multiple charities within a single tax year, for up to $100,000. The threshold for married couples filing jointly is twice as high (so that $100,000 in each spouse’s IRA can be eligible for a QCD).
In order to get credit for a qualified charitable distribution, it must go to a charitable organization that accepts tax-deductible contributions (i.e. a 501(c)(3) organization). It can’t benefit you (the donor) in any way. Charities that cannot receive QCDs include private foundations, donor-advised funds and groups that support tax-exempt charities.
What’s more, a qualified charitable distribution can only come directly from your retirement account. That means your IRA custodian needs to make the check from your IRA payable to a qualifying charity. If you withdraw funds and then try to make a charitable donation, that won’t be considered a qualified charitable distribution.
Using QCDs to Satisfy Required Minimum Distributions
Forgot the rules for RMDs? Here’s a quick refresher. Retirees with certain accounts must begin pulling out their savings when they reach a certain age (i.e. 70 1/2). Withdrawals are taxed as ordinary income. If you don’t take your RMDs, you’ll get hit with a 50% penalty.
If you want a QCD to satisfy your required minimum distribution, you’ll need to transfer funds from your IRA by the end of the year. Any amount above what you’re required to withdraw can’t count as a RMD for the following year. For example, let’s say your annual RMD is $20,000 and you make a $25,000 QCD for 2019. The extra $5,000 cannot go toward your RMD for 2020.
How QCDs Affect Your Tax Bill
With the exception of Roth IRAs, most IRAs are subject to required minimum distributions. But the money you give to charity via a QCD isn’t considered part of your taxable income. In other words, you can lower your federal income tax bill by making a qualified charitable distribution. To find out how a QCD might affect your state income tax bill, you’ll need to contact a tax accountant.
If you make a QCD, it’s best to hold onto the receipt from the charity you donated to, just in case you need that information for tax purposes. Your IRA custodian will report your QCD to the IRS (using Form 1099-R) as either a normal distribution (if it’s from an IRA you didn’t inherit) or a death distribution (if it’s from an inherited IRA).
By reducing your taxable income, QCDs can also reduce the amount of Social Security taxes you pay. They may also help you avoid the 3.80% Medicare surtax on investment income. The surtax applies to individuals with a modified adjusted gross income that exceeds a certain threshold. If it looks like you have less income subject to taxation, you may not have to worry about the surtax at all.
Making a qualified charitable distribution from an IRA to a qualifying charity is one way to lower your tax bill. Such a move could be better than making a tax-deductible contribution since you won’t get credit for a charitable donation if you don’t itemize your deductions.
Don’t forget to make a note of your QCD on your income tax return. You can do that by adding 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 with all tax issues. The SmartAsset matching tool can help you find a financial advisor to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
- 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.
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