What is a qualified charitable distribution?
Did you know that you could avoid paying taxes on your required minimum distributions from your 401k or Traditional IRA?
No, I’m not talking about moving to the Cayman Islands, I’m talking about qualified charitable distributions.
What’s a qualified charitable distribution (QCD)?
A qualified charitable distribution is a direct transfer from your retirement account to a qualified charity.
In other words, instead of transferring the money from your IRA to your bank account, you would pay it directly from your IRA to the charity of your choice.
For those of you who already make consistent contributions to your church, community organizations, or other public charities, this could be a win-win since you would be paying less money to the government and giving more to the causes you care about.
But it gets even better.
Whether you realize it or not, when you reduce your taxable RMD distribution, you could be saving yourself money in five different ways:
Marginal tax rate - by reducing your taxable income, you may fall into a lower marginal tax bracket - meaning you may pay a lower effective tax rate on your total income.
Medicare surcharge tax - if you are a high income earner, then removing taxable RMDs from the equation could save a portion of your income from the additional Medicare tax
Net investment income tax - once again, if you are a high income earner, reducing taxable RMDs means you could be paying less in net investment income taxes
Social security benefits tax - on the flip side, if you are a low income earner, then removing RMDs from your taxable income means your social security benefits might be taxed at a lower rate.
Medicare part B and D - if you have Medicare part B and part D plans, then the premiums (i.e., the cost of those plans) may be adjusted based on your taxable income. So, by lowering your tax bill, you may also lower your premiums for this type of health insurance.
How does a qualified charitable distribution work?
For most custodians, like Fidelity, you would simply fill out a form that looks like this. Once submitted, the custodian will complete the transfer for you.
You’ll then get a 1099-R form from the custodian (sent at the beginning of each tax year), which will show the total distribution and you’ll then indicate on your 1040 the amount that was taxable (i.e., not “QCD”). So, for example, if you had to distribute $6,300 from your IRA as an RMD, and 5,000 of it went to directly to a qualified charity in accordance with the qualified charity distribution rules, then you would write the remainder $1,300 as taxable (check with your CPA or tax software provider to make sure QCD is entered appropriately).
Once entered properly, you will notice that the RMD distribution amount is satisfied, but your taxable income has been adjusted downward accordingly.
Can I make qualified charitable contributions from an inherited IRA?
Your inherited IRA may be eligible for qualified charitable contributions if you meet the following requirements and limitations.
Must be age 70.5 or older
QCD limited to amount that would have been taxed as ordinary income
Must be sent directly to a qualified charity (you can’t withdraw to your bank account and then donate)
You should also be aware that under the SECURE Act, the rules surrounding inherited IRA required minimum distributions have changed drastically (lifetime stretch may no longer be available for most beneficiaries unless its your spouse), so please check with your tax advisor to determine when you actually need to take RMDs and how to coordinate your qualified charitable distributions accordingly.
How do qualified charitable distributions tie into my estate planning?
Qualified charitable distributions help with your estate planning in two ways:
The less you pay the government, the more you can leave to your kids. QCD’s may offer you a more tax efficient way to make donations that you have previously been making with after-tax dollars each year.
You can use qualified charitable distributions as a springboard to consider philanthropy more broadly in your estate plan. Most clients will leave their assets equally to their children, but by sharing your donative history with your children, you may be better able to reinforce values that you want to pass onto them. In other words, by doing a QCD, you now have an additional opportunity to explain to your children what causes you are giving to and why.
If you have any other questions about how qualified charitable contributions may impact your estate planning, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help,
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
