If you have been contributing to a traditional IRA, income tax is due on that money when you take withdrawals in retirement. Annual withdrawals from traditional retirement accounts are required after age 72 (NOTE: RMDs are suspended as part of the COVID-19 CARE ACT for 2020), and the penalty for skipping a Required Minimum Distribution (RMD) is 50% of the amount that should have been withdrawn. However, if you are in the fortunate position of not needing your annual distribution for living expenses and are charitably inclined, you can avoid income tax on your required withdrawal by donating your money directly to a qualifying charity.
A Qualified Charitable Distribution (QCD) is a traditional IRA withdrawal that is paid directly from your retirement account to a qualifying charity. While income tax is normally due on each traditional IRA distribution, the account owner does not need to pay taxes on the amount donated to charity.
Normally, a distribution from an IRA investment account incurs taxes since the account holder didn’t pay taxes on the money when they put it into the retirement account. Account holders 72 or older can make a charitable contribution directly from their investment of up to $100,000 without it being considered a taxable distribution. The deduction effectively lowers the donor’s adjusted gross income.
A Roth IRA does not usually benefit from a QCD charitable contribution because a Roth IRA does not affect your adjusted gross income. There are circumstances where you can. The investment in your Roth IRA was made with post tax dollars and therefore is not taxable when you take a distribution. For someone with a 401(k) the individual would need to first rollover their 401(k) into an IRA in order to take advantage of a QCD.
If you file a joint tax return, your spouse can also make a charitable contribution of up to $100,000, meaning couples can exclude up to $200,000 of their retirement savings from income tax if they donate it to charity. If you donate more than the maximum allowable amount, it is considered income and could be subject to income tax. Qualified charitable contributions must be made by December 31st of each year in order to exclude that amount from taxable income.
To avoid paying taxes on the donation, the donor must follow the IRS rules for QCDs and ensure the organization is an eligible charitable organization. Most churches, nonprofit charities, educational organizations, nonprofit hospitals, and medical research organizations are qualified 501 (c) 3 organizations. The charity will also not pay taxes on the donation.
You can donate part of your required distribution to charity and withdraw the rest of it as retirement income as long as you meet the minimum distribution requirement by the end of the calendar year. Funds must be transferred directly from the retirement account to an eligible charity by the IRA trustee in order to qualify for the tax break. If you withdraw the money from your IRA and donate it at a later date, it will not qualify as a tax-free qualified charitable distribution. You can distribute your required minimum distribution to multiple charities in the same year.
This tax break does mean that the donor cannot also claim the donation as a deduction on Schedule A of their tax return. Other donations to charity that don’t use IRA funds, however, can still be claimed as an itemized deduction. Since the Tax Cuts and Jobs Act increased the base standard deduction, for 2019, to $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly, fewer taxpayers will itemize on Schedule A of their 1040, making the upfront deduction potentially even more important.
If you can afford to donate IRA money, you can benefit tax-wise if you match one or more of the following profiles:
1. You won’t itemize deductions this year due to the bigger standard deduction. So a “regular” charitable donation won’t deliver any tax savings, but a QCD will. That’s the first way to beat the system with a QCD.
2. You want to avoid being taxed on the RMDs that you must take this year from your IRA(s). Replacing taxable RMDs with tax-free QCDs is the second way to beat the system with a QCD.
3. You are looking for a quick-and-easy estate tax reduction strategy. This is a third way to work within the system with a QCD, but it only makes a difference if you have a significant estate.
Using an IRA to make a charitable donation can help lower a tax bill and help a worthy cause, which would be significantly appreciated by the receiving charitable organization given the current economic environment. This is especially valuable for those of you wishing to contribute to support organizations in the fight against COVID-19. All distribution checks need to be made payable to the charity, not the owner or beneficiary, or they will be counted as taxable distributions.
The above is for informational purposes only. As always speak with your retirement plan custodian and/or financial professional about a strategy that makes sense for you and provides sufficient time for the funds to reach the charity. This article should NOT be considered legal, tax or financial advice. You should consult with a professional to determine what may be best for your individual needs. Bernard Herold & Co., Inc. does not make any guarantee or other promise as to any results that may be obtained from using our opinions. No one should make any financial decision without first consulting his or her own financial professional and conducting his or her own research and due diligence. To the maximum extent permitted by law, Bernard Herold & Co., Inc. disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses.
Mario Giammarco, Jr., J.D/M.B.A., Financial Advisor – Bernard Herold & Co. Inc. 1190 Hylan Blvd S.I., NY 10304 Ph: (718) 720-1600 Web: www.heroldinc.com
