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Qualified Charitable Distributions from an IRA: How Giving Back Can Lower Your Taxes

The National Philanthropic Trust estimates that in 2021, individuals in the United States donated over $326 billion to charitable organizations. In many cases, donations serve a dual purpose—they support a cause and give the donor a tax deduction. For retirees, charitable giving can go one step further and also take care of their required minimum distributions (RMDs) at the same time.

So what’s the secret to supporting charity, lowering your taxable income, and dealing with RMDs, all in one fell swoop? Qualified charitable distributions (QCDs). Read on to learn what QCDs are, how they work, and why they’re a great way to donate to your favorite charities in retirement.

What Is a Qualified Charitable Distribution?

A qualified charitable distribution—also known as an IRA charitable distribution—is a withdrawal that, rather than going into your bank account, goes directly to a qualified charity of your choice. Unlike normal distributions, QCDs taken from an IRA aren’t taxed, nor do they count toward your taxable income.

While anyone who’s at least 70½ can make QCDs, the benefits increase substantially for retirees aged 73 or older. Once you turn 73, required minimum distributions, or RMDs, become a key factor in your financial strategy. 

Even if you have plenty of savings and don’t need to take money out of your 401(k) or IRA, federal tax law dictates that you must withdraw a certain amount every year. Since QCDs count toward the required withdrawal amount, they allow you to hit your compulsory RMDs, without hitting your tax returns.

Can Qualified Charitable Distributions Reduce Taxes in Retirement?

Whether you’re still lamenting your last tax bill or getting a head start on planning for next year, QCDs are a valuable tool to maximize your retirement savings. With careful planning, they can help reduce your taxes in two ways:

  • Lower taxable income: In spite of being a withdrawal from your IRA, QCDs don’t count as taxable income. You can remove them from your gross income without having to itemize your deductions. So you end up with lower taxable income, and still have the flexibility to take the standard deduction if it makes the most sense.
  • Reduced RMDs: For retirees with diverse financial options, RMDs can be a burden—you either have to take unneeded distributions that could push you into a higher tax bracket, or pay hefty fines. With QCDs, you can fulfill your RMDs without increasing your tax burden.

How Do Qualified Charitable Distributions Work?

For the most part, the mechanics of QCDs are pretty simple. You just need to notify your IRA administrator that you want to distribute a donation to a given charity. In most cases, the entire process is done online, similar to a normal withdrawal.

There are a few rules to follow when planning your qualified charitable distributions from an IRA:

  • You must donate to a qualified 501(c)(3) organization, which means certain types of charities, like personal foundations, are ineligible. The IRS has an online tool to search for qualified charities, and your tax professional can help you confirm an organization’s eligibility.
  • Any type of IRA is eligible to use for QCDs, including self-employed options like SEP IRAs and SIMPLE IRAs. However, you can’t take QCDs from the self-employed IRAs in the same year that you make contributions.
  • There’s a yearly limit of $100,000 for QCDs. However, that limit is on top of other deductible charitable giving, so you have some flexibility in planning your donations.
  • You can opt to either have your IRA trustee send the money directly to the charity, or send you a check that you pass on to the charity.

Are There Any Drawbacks to Qualified Charitable Distributions?

While QCDs are a flexible tool to reduce your tax burden while supporting causes you believe in, they’re not a perfect solution. There are a few potential issues to be aware of before making a QCD:

  • While 401(k)s are subject to RMDs, you can’t use them for QCDs—only IRAs are eligible to use for the purpose. And while Roth IRAs are technically eligible, using them negates the tax benefits, since distributions are already tax-free.
  • Your QCD must come straight from a retirement account. You can’t take a distribution from your IRA, then later decide to offset it with a donation.
  • Once you make a QCD, you won’t be able to claim it as an itemized deduction. Depending upon your tax situation and overall finances, it might be advantageous to use a donation as a deduction rather than a QCD.

QCDs Aren’t Just a Tax Break—They’re Making a Difference

Qualified charitable distributions are a valuable tool for reducing your taxable income in retirement. But they’re also so much more. Charitable donations are as good for your mental health as they are for your tax return—maybe even better. They’re a way for you to support causes you’re passionate about, help those around you, and nurture a better world and brighter future.

For some, that might mean giving to current causes that are in the news–like political conflicts or natural disasters. For others, long-standing charities like animal shelters or cancer research organizations might be near and dear to your heart.

Whatever the cause, QCDs are an opportunity to make a small dent in your taxes, but make a big difference for someone or something that you care deeply about.

Interested in learning more about whether QCDs are the best way for you to support your favorite causes and maximize your retirement savings? A Certified Financial Planner can help you understand how your charitable giving fits into your overall financial picture. Contact us today.

 

Disclosure: For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third-party data which may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Indices are unmanaged baskets of securities and are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Total return includes reinvestment of dividends and capital gains. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements, or representations whatsoever by us regarding third-party websites. Wealth Legacy Institute is not responsible for the content, availability, or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products, or services available on or through these third-party websites. The opinions expressed by featured authors are their own and may not accurately reflect those of Wealth Legacy Institute®.

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