Did you know that if you are 70½ or older you can make tax-free charitable donations directly from your IRA?
You can donate to qualified charitable organizations by making a qualified charitable distribution (QCD) from an IRA directly to the organization. You can exclude up to $100,000 from your income annually by making charitable distributions. These donations, also known as “charitable IRA rollovers”, would otherwise be taxable IRA distributions.
How QCDs work
You must be 70½ or older to make qualified charitable distributions. To make a charitable distribution, you just instruct your IRA trustee to make the distribution directly from your Traditional 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 annually. It is important to note that QCDs aren’t deducted as charitable contributions on your federal income tax return. Instead, QCDs are simply tax-free distributions from your IRA account, whereas other distributions from your IRA account would be taxed as income.
For a distribution to be considered a Qualified Charitable Distribution, it must be distributed directly from your IRA account to a qualified charitable organization. If you actually receive the distribution and then donate it to a charity, it would not qualify as a QCD. An additional benefit of QCDs is that they count towards satisfying your required minimum distributions (RMDs) for the year, if you are age 72 or older.
Here are some examples to clarify:
- Your RMD for 2021, which you’re required to take no later than December 31, 2021, is $25,000. You make a $5,000 cash distribution from your IRA in February 2021 which you then contribute to your church. In July, you also make a $15,000 QCD to your church. You must include the $5,000 cash distribution in your 2021 gross income, but the $15,000 QCD is excluded from your gross income for the year. The $5,000 cash distribution plus your $15,000 QCD satisfy $20,000 of your $25,000 RMD for 2021. You would only need to withdraw an additional $5,000, no later than December 31, 2021, to avoid a penalty.
- Let’s say you turn 72 in 2021. You must take your first RMD (for 2021) no later than April 1, 2022. You must take your second RMD (for 2022) no later than December 31, 2022. Assume each RMD is $25,000. You don’t take any cash distributions from your IRA in 2021 or 2022. On March 31, 2022, you make a $25,000 QCD to a local animal shelter. Because the QCD is made prior to April 1, it satisfies your $25,000 RMD for 2021. On December 31, 2022, you make a $75,000 QCD to another qualified charity. Because the QCD is made by December 31, it satisfies your $25,000 RMD for 2022. All of the $100,000 of QCDs will be excluded from your 2022 gross income.
As mentioned above, a QCD must be an otherwise taxable distribution from your IRA. Meaning, if you’ve made nondeductible contributions to your IRA then each distribution normally carries with it a pro-rata amount of taxable and nontaxable dollars. A special rule applies to QCDs however — the pro-rata rule is ignored, and your taxable dollars are treated as distributed first.
Your QCD cannot be made to a private foundation, donor-advised fund, or supporting organization (as described in IRC Section 509(a)(3)). The gift also cannot be made in exchange for a charitable gift annuity or to a charitable remainder trust.
Why QCDs are beneficial
Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would involve many steps and could possibly be more costly. You would need to request a distribution from the IRA and then make the contribution to the charity yourself. You would include the distribution in gross income for the year and then take a corresponding income tax deduction for the charitable contribution. But due to IRS limits, the additional tax from the distribution may be more than the charitable deduction you receive. Due to the much higher standard deduction amounts ushered in by the Tax Cuts and Jobs Act passed in 2017, itemizing deductions have become less beneficial for many people, rendering QCDs even more appealing.
QCDs are a great option because they provide an exclusion from income for the amount paid directly from your IRA to the charity. The IRA distribution is not included in your gross income, and you don’t take a deduction for the amount you donated. The fact that it also goes towards fulfilling any applicable Required Minimum Distribution is an added bonus!
QCDs are a very beneficial tax planning tool but incorporating them into your financial plan can sometimes be complex. Be sure to consult your wealth manager or tax professional when considering the benefits of QCDs for you.
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