RMD

Article Dean Dorton

By Matt Smith, CPA | msmith@deandortonstg.wpenginepowered.com and Elizabeth Leatherman, J.D., CPA | eleatherman@deandortonstg.wpenginepowered.com

Qualified Charitable Distributions

You can make a qualified charitable distribution (QCD) by directly transferring funds from your IRA custodian to a qualified charity. QCDs can be counted toward satisfying required minimum distributions (RMDs) for taxpayers over age 70 1/2.

A taxable IRA distribution increases the recipient’s adjusted gross income (AGI), which may increase income taxes and Medicare premiums. In the case of a QCD, the distribution is not included in AGI, and no charitable gift deduction is allowed. In many cases, the substantial increase in the standard deduction levels in recent years has resulted in limited or no tax benefits from charitable contributions. Consequently, QCDs have become more useful as a tax savings tool.

Consider the following two examples in which a QCD is preferable to receiving an RMD and donating a like amount to charity.

Example 1

Facts Tax results Primary reasons for the tax savings from the QCD
  1. Single person, age 73
  2. RMD of $14,000
  3. Social security benefits of $30,000
  4. Other ordinary income of $30,000
  5. Charitable contributions of $14,000 and minimal other itemized deductions
  1. Federal and Kentucky income tax without QCD – $8,579
  2. Federal and Kentucky income tax with $14,000 QCD – $4,710
  3. Tax savings from QCD – $3,869 (45%)
  1. Minimal benefit from the charitable contribution deduction if no QCD
  2. More social security would have been taxable due to the increased AGI if no QCD

Example 2

Facts Tax results Primary reasons for the tax savings from the QCD
  1. Married couple filing jointly, each age 75
  2. RMD of $80,000
  3. Social security benefits of $50,000
  4. Capital gains and qualifying dividends of $100,000
  5. Other ordinary income of $150,000
  6. State and local tax deductions of $10,000
  7. Charitable contributions of $80,000
  1. Federal and Kentucky income tax without QCD – $62,478
  2. Federal and Kentucky income tax with $14,000 QCD – $55,710
  3. Tax savings from QCD – $7,361 (12%)
  1. Reduced benefit from the charitable contribution deduction if no QCD
  2. More investment income subject to the 3.8% net investment income tax due to the increased AGI if no QCD

In limited situations, using a QCD may cost additional taxes. Consider the following example:

Example 3

Facts Tax results Primary reasons for the tax increase if a QCD is made
  1. Married couple filing jointly, each age 75
  2. Kentucky tax-free bond interest of $35,000
  3. Capital gains and qualified dividends of $25,000
  4. Wife receives a 401(k) plan distribution of $100,000
  5. Husband has a $50,000 RMD from his IRA
  6. Itemized deductions, other than charitable contributions, of $18,000 of home mortgage interest and $10,000 of state and local taxes
  7. Charitable contributions of $50,000
  1. Federal and Kentucky income tax without QCD – $32,667
  2. Federal and Kentucky income tax with QCD – $33,805
  3. Tax cost from QCD – $1,138 (3%)
  1. Kentucky provides an exclusion from AGI of up to $31,110 of retirement plan income. Had the QCD not been made, the couple would have had a $50,000 charitable contribution deduction and would have been taxed by Kentucky on only $18,890 ($50,000 less $31,110) of the RMD

Note that our examples may suggest that all of an IRA owner’s RMD may need to be distributed to charity to take advantage of the potential benefits of qualified charitable distributions. That is not a requirement. An IRA owner may distribute only a portion of the RMD to charity as a QCD, taking the balance as a taxable distribution.

Several requirements must be followed to properly make a QCD. Please consult your tax advisor to help you determine if this could be a good tax planning tool in your situation.

This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).

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Article Dean Dorton

Last year a break valued by many charitably inclined retirees was made permanent: the charitable IRA rollover. If you’re age 70½ or older, you can make direct contributions — up to $100,000 annually — from your IRA to qualified charitable organizations without owing any income tax on the distributions.

Satisfy your RMD

A charitable IRA rollover can be used to satisfy required minimum distributions (RMDs). You must begin to take annual RMDs from your traditional IRAs in the year in which you reach age 70½. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (An RMD deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)

So if you don’t need the RMD for your living expenses, a charitable IRA rollover can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid out to you.

Additional benefits

You might be able to achieve a similar tax result from taking the RMD payout and then contributing that amount to charity. But it’s more complex because you must report the RMD as income and then take an itemized deduction for the donation. This has two more possible downsides:

  • The reported RMD income might increase your income to the point that you’re pushed into a higher tax bracket, certain additional taxes are triggered and/or the benefits of certain tax breaks are reduced or eliminated. It could even cause Social Security payments to become taxable or increase income-based Medicare premiums and prescription drug charges.
  • If your donation would equal a large portion of your income for the year, your deduction might be reduced due to the percentage-of-income limit. You generally can’t deduct cash donations that exceed 50% of your adjusted gross income for the year. (Lower limits apply to donations of long-term appreciated securities or made to private foundations.) You can carry forward the excess up to five years, but if you make large donations every year, that won’t help you.

A charitable IRA rollover avoids these potential negative tax consequences.

Have questions about charitable IRA rollovers or other giving strategies? Please contact us. We can help you create a giving plan that will meet your charitable goals and maximize your tax savings