When RMDs Loom Large, QCDs Offer a Gratifying Tax Break

Send money directly to charity from your traditional IRA, and you won’t owe taxes on the amount you donate. It’s a win-win!

A pair of hands cradle a red heart knickknack.
(Image credit: Getty Images)

When you were younger and busy building your nest egg, it’s likely you didn’t give much thought to the impact required minimum distributions (RMDs) could have on your retirement someday.

The plan back then, when you chose to contribute your savings to a traditional IRA, was probably straightforward: to enjoy the account’s tax advantages each year for many years while accumulating as much money as possible.

Somebody might have mentioned something about the IRS eventually getting a share of that money when you reached your early 70s, but that problem seemed a long way off. Now, here you are, and those RMDs are looming. And because of your diligent saving and smart investing, the tax bite — starting at age 72 and continuing every year after that — could be staggering.

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Fortunately, if charitable giving is one of your retirement objectives, there’s a tax-relief strategy that can be a win-win for you and your favorite organizations. It’s called a qualified charitable distribution, or QCD.

Once you turn 70½, the QCD rule allows you to instruct your IRA administrator to direct transfer up to $100,000 annually to one or more eligible 501(c)(3) charities. And because that money is going directly to charity, it isn’t considered taxable income, and you won’t pay taxes on the amount you donate.

A Charitable Tax Deduction Without Itemizing

The ability to make this charitable tax deduction without itemizing can be a significant benefit on its own. If the higher standard deduction that was put in place in 2018 turned itemizing into a no-go for you, you can use a QCD at 70½ to keep up your charitable giving and still receive a tax break. 

But if you’re 72 or older and must take RMDs, the benefits get even better. The QCD amount can then be counted toward your RMD for the year.  Instead of paying taxes on the mandated withdrawal as ordinary income — the way an RMD normally works — you wouldn’t owe any taxes on the portion of your RMD that you gave to charity.

Using your RMD as a charitable contribution excludes that amount from your adjusted-gross income (AGI). This means that along with reducing your income taxes, it also could lower the amount of your Social Security benefit subject to federal income taxes and help you avoid or reduce income-related Medicare surcharges.

We’re talking about an opportunity for tax savings here, so of course there are rules and limitations. Here are some things to consider:

You can’t make a QCD from an employer-sponsored plan. If you have savings in a 401(k), 403(b), deferred compensation or Thrift Savings Plan (TSP), you can’t make a QCD directly to a charity. However, you could directly transfer money from this type of plan to a traditional IRA, then make the QCD from the IRA.

You can’t receive any benefit for making a QCD to a charity. So, for example, you couldn’t pay the entry fee for a charity tennis tournament with the QCD gift or buy something at a charity auction. (If you have questions about what is and isn’t OK, it’s a good idea to consult with your financial or tax adviser.)  

You can spread out the QCD among multiple charities or give to just one. But the money must go only to eligible charities. (The IRS offers a tax-exempt organization search tool on its website.)

You and your spouse both can use a QCD. If you and your spouse are 70½ or older, and you each have your own IRA, you can both take advantage of a QCD and donate up to $100,000 each.

Your QCD amount can be more than your RMD. If you give more, though, you can’t carry forward the excess to future tax years. (You also can donate less than your full RMD, but if you do, you still will need to withdraw the remaining RMD amount and pay ordinary federal income taxes on it.)

Last but not least (and these two are biggies):

You can’t transfer the funds from your IRA to your personal account, then write a check from your account to your charity. The money must be made payable directly from the IRA to an IRS-approved charity.

If you work with a tax preparer or tax accountant, be sure you let that person know you did a QCD. You should receive a 1099 showing the distribution took place, but the form may not clearly designate the distribution as a QCD. If the distribution isn’t properly recorded on your tax return, you could lose your tax break.

The rules (and potential for getting something wrong) may make using QCDs seem off-putting at first. And it may not be a DIY move — at least not the first time you do it. But the benefits for you and your favorite charities make it worth checking out what this strategy has to offer. Your financial adviser or tax adviser can walk you through the pros and cons and how they might apply to your specific circumstances.

Kim Franke-Folstad contributed to this article.

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Scott Tucker, Investment Adviser Representative
President, Scott Tucker Solutions

Scott Tucker is president and founder of Scott Tucker Solutions, Inc.  He has been helping Chicago-area families with their finances since 2010. A U.S. Navy veteran, Scott served five years on active duty as a cryptologist and was selected for duty at the White House based on his service record. He holds life, health, property and casualty insurance licenses in Illinois, has passed the Series 65 securities exam in 2015 and is an Investment Adviser Representative.