For taxpayers who have investments in pretax retirement accounts (such as IRAs, 401(k)s, IRA annuities), the IRS generally requires that taxable distributions be taken from these accounts on an annual basis once the owner reaches the age of 73 (increased from 70.5 to 72 in 2020 with the passing of the SECURE Act, and again in 2022 to the current age of 73 with the passing of SECURE Act 2.0). These are called Required Minimum Distributions or “RMDs.” They begin as a relatively small percentage of all pretax assets; however, the annual percentage is based on life expectancy, so the required distribution tends to increase gradually over time. Depending on the total amount of assets held in pretax retirement accounts, these RMDs can become very large over time and create a higher tax burden when combined with other retirement income streams, particularly because the distributions are taxable as ordinary income in the year received.
For IRA owners who are charitably-inclined and who don’t require these distributions for cash flow, the IRA Charitable Rollover (also known as a Qualified Charitable Distribution or “QCD”) can be a very effective strategy. IRA Charitable Rollovers are a special provision in the tax code that allows an IRA owner to make a tax-free gift of up to $100,000 directly from the taxpayer’s IRA to an eligible charity (or charities) of their choosing. The maximum can be reduced, however, if the individual makes deductible IRA contributions beyond age 70.5.
New in 2023: Historically, Qualified Charitable Distributions have not been permitted to be made directly from a retirement account to a charitable trust. Under the new SECURE Act 2.0, a one-time QCD of $50,000 to certain types of charitable trusts may be allowed, subject to certain restrictions and requirements. Read more – Download PDF Now >>
As always, we recommend you consult your trusted financial adviser. To learn more about the IRA Charitable Rollover, the potential advantages of charitable estate planning, and donor recognition accorded through membership in The Legacy Society, please contact Chris Rollins, CFRE at (856) 552-3287 or [email protected]. Samaritan Healthcare & Hospice, Inc. is a 501(c)(3), not-for-profit organization (EIN: 22-2344036); headquartered at 3906 Church Road, Mount Laurel, NJ 08054.
This article was provided by Mike Cona and Jim Ewing, who are Managing Directors and Partners of Clarity Point Financial Partners, a HighTower company. Jim is a member of Samaritan’s Planned Giving Committee, a volunteer group of the region’s leading financial professionals, lending their time and expertise to guide our charitable estate planning efforts.
Qualified Charitable Distributions: Support Worthy Causes, Reduce Your Taxable Income
Charitable giving can do more than give you a sense of fulfillment for making a difference in people’s lives. It can also play a valuable role in your financial and estate plans.
There are several ways to support charitable organizations, such as charitable remainder trusts, donor-advised funds, appreciated stock, and gifts of cash. The key is to determine which type of gift makes the most sense for you.
If you’re a taxpayer aged 70 ½ and older with an individual retirement account (IRA), you can use qualified charitable distributions to support causes that are near and dear to your heart while reducing your tax obligation.
What Are Qualified Charitable Distributions and How Do They Work?
Created by the Pension Act of 2006, a qualified charitable distribution, or QCD, allows the owner of traditional IRAs and inherited (beneficiary) IRAs, age 70 ½ or older, to distribute directly to qualified public charities up to $100,000 per year without the distribution being included in taxable income ($100,000 will be indexed to inflation beginning in 2024).
Generally, IRA distributions are considered taxable income for the IRA owner. However, qualifying amounts donated via a qualified charitable distribution are excluded from your taxable income.
By strategically lowering your taxable income, you can:
- Reduce your marginal tax bracket.
- Reduce or eliminate income that is subject to the Net Investment Income Tax.
- Reduce Medicare premiums that are subject to the income related monthly adjustment penalty.
- Reduce the tax rate you pay on ordinary dividends and capital gains.
The Mechanics of Qualified Charitable Distributions
Here is a general overview of the rules and process that must be followed to make a donation through a qualified charitable distribution.
You must be age 70 ½ or older. If you turn 70 ½ in May, you cannot make the contribution prior to your birthday.
The distribution must move directly from your IRA to a qualified charity. There is no limit to the number of charities you may choose to support through a qualified charitable distribution, and you’re not obligated to contribute every year.
The check will be made payable to the charity. You can have the check sent directly to the charity or have it sent to you and present the check in person.
Most financial firms have a specific form to initiate such a transaction, which must be completed within the calendar year. Make sure you tell your CPA how much you contributed via the qualified charitable distribution. Your 1099R, the tax reporting form used for distributions, will include the total amount.
A Real-World Example Illustrating the Tax Benefits
Many investors have accumulated significant wealth in IRAs. When they reach the age that requires them to take annual required minimum distributions, or RMDs, they might not need the full distribution to pay the bills and support their lifestyle.
The problem is that the distribution may place them in a higher marginal income tax bracket, subject them to the Net Investment Income Tax, and increase their Medicare Part B and Part D premiums. The increase in your Medicare premiums is called a Medicare income-related monthly adjustment and will increase your premiums two years after the current tax year.
For example, a 73-year-old investor with $3,683,000 in their IRA will need to take a required minimum distribution in the amount of approximately $139,000. This amount will be added directly to their other income sources, such as interest, dividends, capital gains, Social Security, pensions, and more.
This investor can elect to have up to $100,000 sent directly from their IRA to one or more qualified charities. The amount contributed will directly reduce the investor’s income from the IRA distribution, dollar for dollar.
For example, an investor who sends $25,000 to various qualified charities via qualified charitable distribution will report income from their IRA in the amount of $114,000 ($139,000 – $25,000). In a 24 percent marginal federal tax bracket, the tax savings are approximately $6,000.
How Much Should You Contribute?
The amount you contribute should be primarily based on the amount that truly satisfies your annual philanthropic desires. In other words, how much you are willing and able to support the great work done by charitable organizations?
Annual strategic planning can identify opportunities to reduce income taxes and realize benefits in other areas of your financial planning. Always consult with your tax professional when considering methods to reduce taxation because mistakes can be costly.
Financial and tax professionals can “model” your current-year tax return using various amounts of qualified charitable distributions to identify the contribution level that satisfies your desire give and delivers the greatest tax benefit.
Let’s look at the 73-year-old investor with $3,680,000 in their IRA. The required minimum distribution for 2023 is $139,000. For this investor, including all sources of other income, their federal income tax will amount to $42,013, including a $259 Net Investment Income Tax.
The adjusted gross income for this taxpayer, including all sources of income, totals $261,278. This income will have both spouses paying significantly more money for Medicare Parts B and D in 2025. The additional amount over the standard Medicare premium is $196.30/month for each spouse. For 2025, they will pay an additional $4711.20.
Making a qualified charitable distribution in the amount of $25,000 reduces their federal income tax bill from $42,013 to $35,753, a tax savings of $6,260. The additional amount they will pay for Medicare will decrease from $4711.20 in 2025 to $1874.40, a savings of $2,836.80.
In summary, a $25,000 qualified charitable distribution saves this taxpayer $6,260 in federal tax and $2,836.80 in Medicare premiums for a total of $9,096.80.
The tax and Medicare savings can make your charitable giving that much more rewarding. Not only does a qualified charitable distribution provide a means for supporting worthy causes, but it also enables you to reduce your taxable income and keep more money in your pocket. It’s a win-win!
This article was provided by Paul Levin, CFP, ChFC, RICP; a retirement income certified professional, partner of Retirement Refined, LLC (securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Advisor), and a volunteer member of Samaritan’s Planned Giving Committee, a group of the area’s leading professional financial advisors, lending their time and expertise to raise awareness of the potential advantages of charitable estate planning. This article is educational and not intended to provide financial or tax planning advice. Please be sure to consult with your financial and tax professionals prior to initiating a qualified charitable distribution or any charitable transaction.
Understanding Qualified Charitable Distributions: A Guide for Estate Planning and Tax Savings
By Timothy J. Rice, Esq. Founder and Managing Partner, Timothy Rice Estate and Elder Law Firm; and a member of Samaritan’s Planned Giving Committee, a group of the region’s leading financial advisors, volunteering their time and expertise to raise awareness of the impact and advantages of charitable tax and estate planning.
Qualified Charitable Distributions (QCDs) have become an essential tool for individuals seeking to combine philanthropy with smart tax and estate planning strategies. A QCD is a direct transfer of funds from a person’s individual retirement account (IRA) to a qualified charity. Unlike regular charitable donations, QCDs allow individuals to donate to causes they care about while simultaneously reducing their taxable income. Since they were introduced as part of the Pension Protection Act of 2006, QCDs have become a popular tax planning tool.
The Setting Every Community Up for Retirement Enhancement Act (SECURE Act), passed by Congress and signed into law by Pres. Donald Trump in 2019, was significantly revised in 2023. Previously, the limit on qualified charitable distributions was capped at $100,000. But under what became known as SECURE Act 2.0, the limit was indexed for annual inflation, allowing for increased contributions in future years. SECURE Act 2.0 also allows for a one-time qualified charitable distribution of up to $50,000 directly from an IRA into a charitable remainder trust.
How QCDs Benefit Estate Planning and Taxes
QCDs offer unique benefits that align financial goals with charitable giving. Some key benefits include:
- Reduce taxable income: QCDs are excluded from your taxable income, unlike regular withdrawals from traditional IRAs, which are taxed as ordinary income. This exclusion can help you avoid moving into a higher tax bracket and reduce the impact on income-based calculations, like Medicaid qualifications.
- Satisfy Required Minimum Distributions (RMDs): For individuals aged 73 or older (the new RMD age under SECURE Act 2.0), QCDs count toward satisfying RMD requirements. This is especially useful if you don’t need the income from your RMD and would prefer to direct those funds to a charitable cause instead of incurring additional taxable income. Fulfilling your RMD obligations through QCDs also avoids the steep penalty for failing to take an RMD, which was reduced to 25% (or 10% if corrected promptly) under SECURE Act 2.0.
- Support your legacy: Including QCDs in your estate planning strategy allows you to leave a philanthropic legacy while reducing the size of your taxable estate. This can help preserve more wealth for your heirs.
- Simplify estate planning: Directing IRA funds to charitable causes via QCDs can simplify the transfer of wealth, reducing the administrative burden on your estate and beneficiaries.
What You Need to Know About QCDs for Estate Planning
Work with Your Advisors
To maximize the benefits of QCDs and ensure compliance with the law, it’s essential to work closely with a team of trusted advisors. A financial advisor can help you determine the optimal amount to donate based on your income and tax situation, while a tax professional can confirm how the QCD will impact your overall tax liability. An estate planning attorney can ensure the QCD aligns with your broader estate planning strategy, including provisions for other assets, heirs and charitable goals. Together, this team can craft a cohesive plan tailored to your financial and philanthropic objectives.
Document Your Charitable Intentions
Including your QCD intentions in your estate plan ensures your wishes are clearly articulated and executed. This documentation is particularly important if you plan to use QCDs over several years or if your charitable giving is tied to specific causes or organizations. By clearly outlining your intentions, you reduce the likelihood of misunderstandings or disputes among heirs or beneficiaries and ensure that your legacy reflects your philanthropic values.
Consider the Timing
Timing is critical when making QCDs. Planning early in the tax year gives you ample time to coordinate with your IRA custodian and ensures the funds are distributed to the charity on time. Early planning also helps align your QCDs with RMD schedules, avoiding potential penalties for missed RMDs. Procrastinating could result in missed opportunities for tax savings or delays in processing the donation, which could jeopardize your ability to claim the QCD for that tax year.
Verify Eligible Charities
Not all charitable organizations qualify to receive QCDs, so it’s vital to confirm that your chosen charity meets IRS requirements. Eligible recipients must be 501(c)(3) organizations and cannot include donor-advised funds, supporting organizations or private foundations. Before initiating the transfer, verify the organization’s status using the IRS’s Tax-Exempt Organization Search tool. Failing to confirm eligibility could result in the QCD being disallowed, turning it into a taxable IRA withdrawal and negating its tax benefits.
Review Contribution Limits
While the annual QCD limit is currently $100,000 per individual, it’s important to consider this cap when planning donations, especially if you’re considering funding split-interest charitable entities like charitable remainder trusts or charitable gift annuities. If your charitable goals exceed the annual limit, you may need to coordinate multiple years of giving to achieve your objectives without exceeding the cap.
Communicate with Charities
Once you’ve selected an eligible charity, ensure open communication to confirm its ability to receive QCDs and its preferred method of receipt. Some charities have specific protocols for processing QCDs, and coordinating in advance can avoid administrative hiccups. Providing your name and contact details along with the QCD can also help the charity properly acknowledge your gift, which is important for record-keeping.
Looking Ahead
The SECURE Act 2.0 has made QCDs an even more attractive option for individuals nearing or in retirement who wish to incorporate charitable giving into their tax and estate planning. Whether you’re interested in reducing your tax burden, satisfying RMD requirements or leaving a philanthropic legacy, QCDs offer a powerful way to achieve your goals.
For those interested in exploring how QCDs can fit into your estate plan, consulting with knowledgeable professionals is the first step toward creating a strategy tailored to your unique needs and aspirations.
As founder and managing partner of Timothy Rice Estate and Elder Law Firm, Timothy J. Rice, Esq. has focused his law practice on estate and elder law matters since 1991. He can be reached at (833) 888-0462 and [email protected].