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QCD: Doing Well by Doing Good

Doug Garrison, CFP, MBA - Senior Wealth Advisor

You may know some very fortunate and charitably-minded people.

These folks have lived frugally, saved often, and invested well. As they get into their 70’s and 80’s, they discover that they will not need all the money that Uncle Sam mandates them to take each year from their Individual Retirement Arrangements (IRAs).

You see, at age 72 (or age 70-1/2 if born before July 1, 1949) Uncle Sam forces you to begin withdrawing (and paying taxes!) on a required amount from your IRA.

That what Uncle Sam requires is more than what you actually need is a nice problem to have. If you are fortunate enough to have this problem now, or expect it at some point in your future, there may be a solution for you. Read on...

Uncle Sam's kindness doesn't extend forever.

Some background to help frame the issue. IRS tax rules encourage workers to contribute to an IRA—or to other tax-qualified retirement plans such as a 401(k)—by allowing contributions on a pre-tax basis. You don’t pay taxes currently on allowable pre-tax contributions to the IRA or 401(k) plan. Your taxable income is reduced by your pre-tax contributions, and earnings on those contributions accumulate on a tax-deferred basis.

But Uncle Sam’s kindness doesn’t extend forever. He wants to tax that money at some point. The current rule is that an IRA owner age 72 or older has to begin drawing out funds according to an IRS-approved schedule. The amount is called the Required Minimum Distribution (RMD). This rule is intended to force out the balance over one’s remaining lifetime, so that it’s all eventually taxed. Uncle Sam gets his share—finally. (The only certainties in life—death and taxes—come together through the RMD schedule that dictates required distributions.)

So, each pre-tax dollar contributed and each dollar of earnings coming out of the IRA are taxed as ordinary income to the IRA owner.

In addition to raising your taxable income, RMDs can also inflict more financial “pain” through increased income-related surcharges.

That income that you incur from IRA distributions can cause you to have to pay an income-related additional monthly premium for Medicare benefits. In other words, in addition to raising your taxable income, RMDs can also inflict more financial “pain” through increased income-related surcharges.

With that as background, let’s return to the happy plight of those fortunate souls who don’t need the entirety of their RMDs. Is there an option for them?

The US tax code allows IRA owners age 70-1/2 or older to make charitable gifts of up to $100k directly from their IRA. And what’s even better, that gift can meet all or a portion of your minimum distribution requirement. It’s called a “Qualified Charitable Distribution” (QCD). While such a gift cannot be taken as an itemized deduction on your tax return, it is excluded from income.

In other words, one of our fortunate friends can direct a distribution from her IRA to a favorite charity. If she’s required to take RMDs, the QCD can satisfy that requirement. Instead of adding that amount to her income, with attendant taxes, she gets to avoid paying income taxes on it and the QCD reduces her taxable income below what it otherwise would be. She does well by doing good!

This is better than taking her full RMD and then writing a check to the charity. A simplified example with some hypothetical numbers may help show why. Let’s imagine a retired couple over the age of 72 with the following facts:

  • Their RMDs for 2021 are $125,000
  • They expect taxable investment income of $75,000
  • Their net taxable Social Security benefits are $40,000
  • They’re undecided whether they’ll contribute $100,000 to their favorite charities. (In real life, you don’t have to give away $100,000—that’s the maximum allowed from each IRA, but for simplicity’s sake, that’s the amount we’re using in this example.)
    • They may give nothing (Case A, below);
    • They may give $100,000 in cash (Case B, below);
    • Or they may do a Qualified Charitable Distribution (QCD) and have $100,000 sent from their IRAs to their favorite charities (Case C, below)
  • To calculate their taxes and keep the focus on the QCD, we’ve simply applied the 2021 tax rates to their taxable income, disregarding the possibility of Alternative Minimum Tax or any tax credits.
  • And let’s also simplify by assuming that the only itemized deduction they might be able to take on their tax return is the charitable contribution. If they don’t take the deduction, they’ll use the standard deduction of $27,800 for taxpayers over the age of 65 filing as a married couple.

Table of Qualified Charitable Distribution (QCD) Cases

    To note from the example:

    1. Using the QCD reduces their adjusted gross income from $240,000 to $140,000 (the $100k QCD doesn’t count as income). They may thus avoid the Medicare premium surcharges for couples making more than $176,000.
    2. They would have more income for themselves if they don’t make the gift to charity. But by using the QCD instead of cash, they save $6,570 that would otherwise have been paid in taxes (the difference in assumed tax for Case C vs. Case B).
    3. The tax benefit they get from making the $100,000 cash contribution to charity was really only on $72,200 of the gift. The benefit on the first $27,800 was already obtained through the standard deduction. By using the QCD instead of cash, they exclude $100,000 from their income, get the tax benefit of the standard deduction, and have less income subject to their marginal tax rate.

    First dollars out of an IRA each year count against your RMD requirement. If you withdraw your RMD before making the QCD you’ll have to count your RMD as income.

    There are some technical requirements if you’re going to make a QCD. The first dollars out of an IRA each year count against your RMD requirement. If you withdraw your entire RMD first, before making the QCD, you’ll have to count your RMD as income.

    You should consult with your CPA or other tax preparer or your financial advisor, should you choose to do a QCD. If you’re one of the fortunate ones who doesn’t need all of what Uncle Sam says you have to take out of your IRA, consider the benefits of “doing well by doing good,” using a QCD to help out one or more of your favorite charities. We’re available if you have questions or want to discuss in the context of your own financial situation. Let’s talk.

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    Disclaimer: The information provided here is general and intended as educational in nature. It is not intended nor should it be considered as tax, accounting, or legal advice. Investec Wealth Strategies and its advisors do not provide tax, accounting, or legal advice. We recommend you seek the counsel of your attorney, accountant or other qualified tax advisor concerning your situation.