It’s no surprise that the 2018 Tax Cuts and Jobs Act changed the way people approach their tax planning strategy. With the standard deduction nearly doubling to $12,000 for single filers and $24,000 for joint filers, a number of households will not be able to take advantage of itemized deductions as they did in previous years.
This policy change means that avid donors to charities need to approach their charitable giving in a new way in order to receive the tax benefits. Retirees have a unique opportunity that others do not. This comes in the form of donating all or a portion of your required minimum distributions (RMDs) to a qualifying public charity.
Remember your RMDs kick in when you turn 70 ½, and failing to withdraw the IRS mandated the amount of money before December 31 will result in a hefty 50% penalty on the amount that was supposed to have been withdrawn. This excludes the first year when you are able to delay your first RMD until April 1 following the year you turn 70 ½. Keep in mind that if you do this, you will still need to take your RMD for the current year by December 31, meaning if you delay your first RMD, you will need to take another one in the same calendar year.
How can you use your RMDs to support your charitable donations? You can do this through a process called Qualified Charitable Distributions (QCD). What are QCDs and how can they change the way you approach charitable giving? Let’s find out!
A Qualified Charitable Distribution is a direct payment from an IRA custodian to a qualifying public charity. QCDs are an excellent strategy for retirees because it allows them to be tax-efficient while still maintaining their charitable efforts. The annual limit for a QCD is $100,000 and this amount can be spread over multiple charities throughout the year.
For retirees specifically, their QCD is tied to their annual RMD. When you take your RMD, you are required to pay ordinary income tax on the money. When you donate some of your RMD through the QCD, you avoid paying income tax on the money, which increases your gift to the charity and lessens your yearly tax bill. You don’t have to donate your entire RMD to charity. Let’s say your annual RMD is $4,000, and you donate $2,000 to charity. The remaining $2,000 you will pay ordinary income tax on.
Reducing your overall taxable income can lead to many benefits including certain tax deductions and credits specifically on Social Security and Medicare. It is important to note that though the money donated through a QCD is not taxed and does not need to be itemized, you can’t also claim a charitable tax deduction. Be sure to check with your financial advisor and tax professional to ensure you have everything in order.
Effective tax planning is important for everyone but particularly retirees as cash flow changes and income fluctuates. Another great thing about QCDs is that you aren’t required to itemize them on your taxes which allows you to receive the tax benefits under the new law. Simply ensure that the 1099 form your IRA custodian sends you clearly shows that a QCD occurred as you prepare your tax documents.
The Nitty Gritty
As with many systems and processes, QCDs come with certain rules and regulations that must be adhered to for the process to run smoothly. First, a QCD can only come from a traditional IRA.
In order for you and the charity to receive the benefits of a QCD, the transfer of funds needs to come directly from the IRA custodian to the charity itself. Should you as the owner withdraw the money from your IRA to your own bank account and then write a check, you will still need to pay income tax on the money you withdrew, thereby defeating the purpose. Most IRA custodians will make the transfer directly but some will mail the account owner a check. If this is the case for you, simply give the check directly to the charity.
If you are using a QCD in place of your yearly RMD it is important to note that if you donate more than your RMD to a charity, that amount will not roll over to the next year. Each year has a separate RMD requirement that must be met.
It is also important to know that not every charity qualifies for a QCD. In order to qualify, a charity must be a 501(c)(3) organization eligible to receive tax-deductible contributions. There are a few types of charitable giving that don’t qualify:
- Donor-advised funds
- Private foundations
- Supporting organizations
Be sure to check out the charity you wish to support and ensure that they meet the requirements before donating a QCD.
A Financial Planner Can Help
Retirees who are looking to keep up their charitable efforts in their golden years have a unique opportunity to donate their RMDs. This is a great way to maintain charitable giving while also remaining tax-efficient. Rember, since a QCD doesn’t go on your tax return, the higher standard deduction limits won’t impact the gift.
Here at TFS, we are passionate about helping you make your money work for you. Your life is made up of so many moments and we want to assist you in creating the moments that align with your goals and values.
QCDs are an excellent strategy for retirees. Are you thinking about new ways to donate to charity this year? Set up a time to chat with us so we can help you come up with the best strategy for you.