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Quality Charitable Distributions, known as QCDs, are a direct transfer of funds from your retirement account to a qualified charity. QCDs allow you to donate money to a charity of your choice while also excluding the donation from taxable income. This can help lower your taxable income and may reduce the impact of certain tax credits and deductions. In this blog, we will explain QCDs and how they might work for you.
The key takeaways of this blog are:
● How QCDs work
● Why QCDs are important
How QCDs work
You still must be 70½ or older in order to make QCDs. To do so, you direct your IRA trustee to make a distribution directly from your IRA (other than SEP and SIMPLE IRAs) to a qualified charity. The distribution must be one that would otherwise be taxable to you. You can exclude up to $100,000 of QCDs from your gross income each year, thereby avoiding taxation on those amounts. If you file a joint return, your spouse can exclude an additional $100,000 of QCDs as well. Just keep in mind that you would not get to deduct QCDs as a charitable contribution on your federal income tax return — that would be double-dipping!
QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution from the plan. However, distributions that you actually receive from your IRA (including RMDs) that you subsequently transfer to a charity, do not qualify as QCDs.
Here are some examples to help better explain the benefits of a QCD:
- Assume that your RMD for 2022 is $25,000. You receive a $5,000 cash distribution from your IRA in February 2022, which you then contribute to Charity A. In June 2022, you also make a $15,000 QCD to Charity A. You must include the $5,000 cash distribution in your 2022 gross income because it was paid to you before it was donated to Charity A (but you may be entitled to a charitable deduction if you itemize your deductions). You exclude the $15,000 of QCDs from your 2022 gross income because it was directly donated to Charity A. Your $5,000 cash distribution plus your $15,000 QCD satisfy $20,000 of your $25,000 RMD for 2022, therefore you’ll need to take a $5,000 distribution no later than December 31, 2022, to avoid a penalty.
- Assume you turn 72 in the second half of 2022. You must take your first RMD (for 2022) no later than April 1, 2023. You must take your second RMD (for 2023) no later than December 31, 2023. Assume each RMD is $25,000. You decide not to take any cash distributions from your IRA in 2022 or 2023. On March 31, 2023, you make a $25,000 QCD to Charity B. Because the QCD is made prior to April 1, it satisfies your $25,000 RMD for 2022. On December 31, 2023, you make a $75,000 QCD to Charity C. Additionally, because the QCD is made by December 31, it satisfies your $25,000 RMD for 2023. You can exclude the $100,000 of QCDs from your 2023 gross income.
As indicated above, a QCD must be an otherwise taxable distribution from your IRA. If you’ve made nondeductible contributions, each distribution carries with it a pro-rata amount of taxable and nontaxable dollars. However, a special rule applies to QCDs — the pro-rata rule is actually ignored and your taxable dollars are treated as distributed first. (If you have multiple IRAs, they are aggregated when calculating the taxable and nontaxable portion of a distribution from any one IRA. RMDs are calculated separately for each IRA you own but may be taken from any of your IRAs.) This just got a little technical, so make sure you talk it over with your advisor prior to making any QCDs.
Two important things to keep in mind:
- The gift cannot be made to a private foundation, donor-advised fund, or supporting organization.The gift cannot be made in exchange for a charitable gift annuity or to a charitable remainder trust.
- Due to the SECURE Act, individuals can now make contributions to their traditional IRAs after reaching age 70½. If individuals intend to make deductible traditional IRA contributions in the year they reach age 70½ or later, they should note that the amount of a charitable distribution that can be excluded from income as a QCD may be reduced; however, any amount that cannot be treated as a QCD could qualify as a charitable deduction (assuming deductions are itemized).
Why QCDs are important
Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would be a bit more cumbersome, and more expensive. In addition to eliminating the tax consequence of the distribution, the QCD eliminates the cumbersome step of distributing the money to you, and then requiring you to turn around and write a check to the charity. Additionally, the exclusion from gross income for QCDs also provides a tax-effective way for taxpayers who don’t itemize deductions to make charitable contributions.
Bottomline
If you are over 70, or almost there, it might be time to start thinking about how you can use QCDs to your advantage while also supporting a charity that’s important to you. As always, seek advice from a financial planner in order to better understand how to initiate a QCD and help you decide on the right distribution amount. You’ve worked hard to earn your money, now let it do some work for you.