You may have heard the term QCD, but what is a QCD? Are you charitably minded? Are you over the age of 70 ½? Do you have money in tax-deferred accounts such as IRAs?
What is a QCD?
For those of you who are charitably inclined, and have an IRA (Individual Retirement Account) or 401(k), or another type of retirement plan, you may want to know more about a qualified charitable distribution (QCD). A QCD may be used by owners of retirement accounts who are at least 70 ½ years of age. A QCD provides tax benefits to the account owner that they may not have been eligible for prior to reaching the age of 70 ½.
At the age of 70 ½, there is a required amount that must be withdrawn from accounts such as IRAs, 401(k)s, and SIMPLE or SEP IRAs. This is known as a required minimum distribution (RMD). The amount will depend upon the age of the account owner and the account balance. The amount withdrawn is typically a taxable distribution for the account owner. However, the account owner may elect to have some, or all, of the RMD (up to $100,000) sent directly to a charitable organization or church. By sending this amount to the charity from the account, bypassing the account owner, the withdrawal will not be taxable. This is the benefit of a qualified charitable distribution.
What is a QCD with an example?
Let’s look at an example of how a QCD works and could provide tax benefits in greater detail.
John and Jane are both 72 as of December 31, 2019. Jane has an IRA, and as of December 31, 2018, her account had a balance of $500,000. Based on this information, Jane’s required minimum distribution for the year is $19,531.25, and this withdrawal will be taxed at their marginal tax rate as ordinary income. John and Jane used to itemize their deductions when filing their tax returns. However, they no longer have a mortgage with interest to deduct, and because of the increase in the standard deduction from the Tax Cuts and Jobs Act of 2017, they will claim the standard deduction in 2019.
They are giving $1,000 per month to their church in the form of a written check from their bank account, and even with $12,000 in annual charitable contributions, they still don’t have enough deductions to itemize. While getting a tax benefit is not the primary reason for their charitable activity, it would be an added bonus.
Jane would benefit from a qualified charitable distribution in this case. In order to receive the tax benefit, they would not write a check from their bank account each month to their church. Rather, when they take Jane’s required minimum distribution for the year, they would send $12,000 directly to their church, and take the remaining $7,531.25 as their RMD. The $12,000 that was sent to their church is not taxable to Jane, and leaves the church with the same amount of donations had Jane continued to write a monthly check. Only the $7,531.25 that Jane received from her IRA will be taxable to them.
QCDs Rules
There are four things to remember with QCDs.
Rule #1 – You must be at the age of 70 ½ or older. For example, if we turn 70 ½ in June of 2020, we cannot utilize the QCD in January of 2020. We must wait until we surpass the age of 70 ½.
Rule #2 – The money must go directly from the custodian of your tax-deferred account to your charity. Your charity must also be classified as a 501c3 organization to qualify.
Rule #3 – There is a limit to how much we can give, which is $100,000 per year.
Rule #4 – Be sure to keep all documentation for your tax professional. You will need to get receipts of all donations. Your 1099 will not show that your distribution was for a QCD.
In Conclusion
Ultimately the question is, why is this beneficial to me? This could be beneficial if you like to give to your church or your charity where in the past you have given cash. You’ve now surpassed the age of 70 ½, and you can give that money directly from your tax-deferred account. It satisfies requirements for your RMD per IRS guidelines, and that distribution won’t be counted as income for your taxes. Depending on your situation, lowering your taxable income may add even more benefits. By reducing your income, you may be able to lower the amount of your Social Security becoming taxable. It may also help you stay and lower your Medicare premiums. This is a strategy that could lend multiple benefits. It is crucial that you are working with a professional who clearly understands the complexity of the QCD.
These are all things to consider in your overall distribution plan that you need to be discussing with your advisor and tax professional, to see if they would benefit you.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.