This post was originally published in February 2018 and has been updated to reflect 2019 tax law changes.
If you have reached 70.5 in age and have an IRA, you may benefit from donating all or a portion of your IRA required minimum distribution (RMD) to charity. By making a qualified charitable distribution (QCD), you may avoid tax on your RMD to the extent of the QCD.
qualified charitable distribution (qcd) rules
The strategy works only if the charitable distribution meets the requirements of the QCD rules. This means that:
- The gift may only be made from an IRA; charitable gifts from pre-tax employer retirement plans are not permitted.
- The taxpayer must be 70.5 or older on the date of charitable gift.
- The gift must be to 501(c)(3) entity.
- The gift must be made directly from the IRA custodian to the charity (although may be made by a check made out to the charity as payee and physically delivered by the taxpayer).
- Donor-advised funds are not eligible for QCDs.
- The amount of QCDs per each taxpayer may not exceed $100,000 in any one tax year.
Under the tax rules effective in 2018, in 2019 the individual standard deduction increases to $12,200 ($24,400 for a married couple) and is indexed for inflation. Individual taxpayers who are 65 or older are also entitled to an additional $1,650 deduction (an additional $2,600 total for a married couple who are both 65 or older). The new rules also cap the deduction for state and local taxes at $10,000. Unless your other deductions for expenses such as mortgage interest, medical expenses greater than a specified percentage of your Adjusted Gross Income and charitable deductions exceed $13,850 for an individual or $27,000 for a married couple, claiming the standard deduction will be to your benefit. If you do claim the standard deduction, you unfortunately forgo any tax benefit from your charitable gifts.
Using your ira rmd to get the tax benefit of the charitable deduction
The tax laws require taxpayers, who have reached 70.5 and own an IRA, take RMDs annually. These distributions are normally taxable. You may avoid the tax on your RMD to the extent that you make gifts directly from your IRA to a 501(c)(3) charity that meets the requirements for a QCD. Although there will be no additional charitable deduction when the standard deduction is being claimed, the same tax benefit will be received by avoiding tax on the RMD.
An example might help. Assume that Jane, a single taxpayer, has reached 70.5 and is subject to a $20,000 RMD from her IRA for 2019. She is reasonably confident that she will be using the standard deduction for 2019, as her itemized deductions will not exceed $13,850. Jane needs some but not all the RMD for her living expenses and typically gives around $5,000 to charities each year. What she does then is to make $5,000 in qualifying charitable gifts directly from her IRA and then takes the rest of the RMD as a distribution to herself. By doing so, Jane satisfies her full RMD requirement but owes tax on only $15,000. In effect she receives the benefit of a charitable deduction for $5,000.
caveats and other considerations
There are many considerations to keep in mind. Some are obvious; some less so.
Perhaps the most important assumption is that you do not need the full amount of the RMD for living expenses. Likewise, the strategy presumes that you would choose to make the charitable gift, regardless of the tax benefit. If there is no true charitable intent, better to pay the tax on the RMD and keep the net proceeds.
An important alternative planning strategy to evaluate is using securities with large unrealized gains in brokerage accounts for charitable gifts. These securities may no longer be attractive holdings and using them for charitable gifts is a way of unloading them without incurring capital gains. This optional strategy must also be considered, particularly if there is a reasonable chance that the taxpayer will be eligible to itemize for the given year.
A second alternative planning strategy to consider is whether it may be possible to “bunch” expenses that could be itemized, like charitable deductions, into one tax year when you can control the timing. This strategy enables you to itemize some tax years while claiming the standard deduction in “non-bunching” years.
What if the tax year under consideration is the year the taxpayer turns 70.5? Although subject to the RMD rules for that year, the initial RMD may be deferred until April 1st of the following year. Is this a better strategy, particularly if the amount of the RMD far exceeds the amount of the desired charitable gifts, even if the taxpayer will be forced to take two RMDs the following year?
What if you are unsure if you will be able to itemize or will be taking the standard deduction? All things considered, you probably are not going to be hurt by using a QCD assuming there is no preferable strategy. This is because even if you do ultimately itemize, it will be in your best interests to have the charitable gifts reduce your adjusted gross income, as opposed to counting as a charitable deduction. Reduced AGI helps with other tax calculations although perhaps less so under the new rules. Talk to your CPA about that one!
One trap for the unwary is that the law presumes that the RMD is satisfied as distributions are taken from the IRA. For example, assume that Bob, who has a $10,000 RMD, takes a $5,000 RMD distribution in cash before deciding that he wants to make $10,000 in qualifying charitable gifts to save some tax. Even if he subsequently makes $10,000 in QCDs during the same tax year or the same amount of his RMD, he will still have $5,000 in taxable income from the initial RMD distribution.
Finally, note that state tax rules may differ.
In addition to consulting with your financial advisor, seek advice from your CPA or other tax preparer to determine whether using a QCD to satisfy your RMD may be beneficial to you or whether there may be a better strategy for you. If your charitable gifts are significant, the potential tax savings will be significant. It may even be beneficial to you to consider rolling over an old 401(k) to an IRA to take advantage of this strategy although there are other important considerations to analyze before making a rollover.
Please contact your RSWA Financial Advisor Team with any questions you may have about this article or your portfolio. Feel free to forward the article to anyone who may find it helpful, including anyone who has or will reach 70.5 in age or will this year.