What is a Qualified Charitable Distribution and Its Tax Benefits
What is a Qualified Charitable Distribution and Its Tax Benefits?
Enjoying retirement is one of the many perks of building wealth during your career. Although you aren’t working anymore, you still should be cognizant of your finances. After all, you could be missing out on important tax savings that will help grow your wealth for years to come.
One of those important tax savings could be implementing qualified charitable distributions into your financial plan. A qualified charitable distribution, or QCD, allows individuals who are ages 70.5 or older to donate up to $100,000 total to one or more charities directly from a taxable IRA, rather than taking their required minimum distribution. There are some key factors to understand and consider when deciding whether you are eligible for Qualified Charitable Distributions, so let’s take a deeper dive into the nature of QCDs.
What is a Qualified Charitable Distribution (QCD)?
A qualified charitable distribution counts toward your Required Minimum Distribution, or RMD, from a taxable IRA. Qualified Charitable Distributions will reduce taxable income up to $100,000 per individual. Reducing taxable income is especially important for individuals looking to minimize the taxation of social security income and Medicare premiums. Joint filers can have up to 85% of social security income that is taxable when the filer’s Modified Adjusted Gross Income, or MAGI, is more than $44,000, for example. A Qualified Charitable Distribution will lower the Modified Adjusted Gross Income leading to the tax being lowered or potentially eliminated.
A standard monthly Medicare Part B premium begins at $170.10 a month per person for individuals that file taxes jointly and whose Modified Adjusted Gross Income is less than $182,000. When the MAGI exceeds $182,000, monthly Medicare premiums begin to increase in six thresholds and can reach as high as $578.30 a month per person. With the use of a Qualified Charitable Distribution, individuals can experience greater tax savings than cash donations. This occurs being a QCD will reduce an individual’s Adjusted Gross Income. Even if cash contributions are less than standard deductions preventing itemized deductions, a qualified charitable distribution will still allow individuals to receive tax benefits.
How Does a Qualified Charitable Distribution Work?
If you are over the age of 70.5 years old you can opt to take money from your IRA and donate it to qualified charities. QCDs can be made from either a traditional IRA or a Roth IRA, but donations from a Roth IRA have no tax benefits because the account is already tax free.
You cannot take QCDs from 401(k) plans, but you can take QCDs from active Simplified Employee Pension Plan IRAs or Savings Incentive Match Plan for Employees IRAs as long as no contribution has been added to the plan in the year the Qualified Charitable Distribution is taken. Another important nuance to note when considering making a QCD is the charity the donation is going to. Not all charities qualify for a QCD. Make sure you consult with a tax professional to ensure that the organization you plan to give a donation to is eligible for a QCD and its tax benefits.
Although a QCD is taken from your IRA, it does not count towards taxable income on your tax returns. Instead, QCDs are deducted from your gross income without the need to itemize your deduction. Both of these actions will lower your income allowing you to take a standard deduction rather than itemizing. Qualified charitable distributions also count towards your required minimum distribution. As determined by the SECURE Act 2.0 of 2022, there are now different RMD ages depending on when you were born.
Required Minimum Distributions, or RMDs, increase your taxable income. In some cases, an RMD can push your income into a higher tax bracket causing you to pay more income tax. That is where a QCD comes into play. Qualified Charitable Distributions can fulfill part or all your Required Minimum Distribution without contributing to your taxable income. Individuals can take up to $100,000 in QCDs allowing you to deduct up to $100,000 from taxable income.
Type of Charity that can Receive a Qualified Charitable Distribution
The types of charities that can receive a QCD is defined in the tax code. QCDs cannot be made to donor-advised fund sponsors, private foundations or supporting organizations even though these are categorized as charities. Unlike other tax strategies, like cash donations and appreciated securities, an individual that makes a QCD which exceeds the required minimum distribution for a given year cannot carry over the excess to the next tax year.
Donors also cannot receive any benefits from making a QCD. For example, purchasing something at a charity’s auction or event cannot be considered a Qualified Charitable Distribution. Consulting a tax expert is the best course of action if you are interested in making a QCD. State regulations vary for QCDs, and some charities will not accept them.
Choosing a Beneficiary
Certain accounts are more beneficial to leave to inheritors. For example, typically if you expect to leave an IRA account to an heir you will want a Roth IRA. This is because a Roth IRA is more tax efficient. Due to the 2020 Secure Act, inherited IRAs require full distribution within 10 years for non-spouse beneficiaries. Traditional IRA accounts will be taxed as ordinary income making a Roth IRA the better choice. If you are leaving your IRA to a charity, it is less important to change your plan because most charities are exempt from paying taxes.
When it comes to the tax code, it is crucial to have a tax professional in your corner ensuring the proper practices and best results. Taking control of your finances can be complicated and overwhelming, yet seeking professional financial advice is a great way to support your economic well-being. Having someone with the experience and knowledge to develop strategies around investment, taxation and estate planning is priceless.
Fragasso Financial Advisors Pittsburgh wealth management specialists are experienced professionals when it comes to understanding markets, utilizing the latest technology, and responding to changing regulations. Moreover, their commitment to one-on-one service means they can craft tailored solutions that fit your individual situation while helping you achieve peace of mind. To learn more about Qualified Charitable Distributions and some of the benefits it can have for your finances, visit this article from the Fragasso Financial Advisor’s blog for more information.
Investment advice offered by investment advisor representatives through Fragasso Financial Advisors, a registered investment advisor.