Charitable Gifting with IRAs
Pre-tax retirement accounts are great while you are contributing, but the tax bite can be quite a shock when it’s time to take distributions in retirement. There is one way, however, to avoid paying tax on certain pre-tax IRA distributions. The secret is to make qualifying IRA distributions directly to charity!
Certain rules must be met in order for qualified charitable distributions (QCDs) to be excluded from taxable income. First, you have to be at least 70.5 years old at the time of the gift. This is because in 2006 when QCDs were first allowed by law, 70.5 was the required minimum distribution (RMD) age. Since then, the RMD age has increased, but the law establishing QCDs hasn’t changed, so it’s possible to make QCDs before you reach RMD age in some cases. Second, the gifts must be made directly from your IRA to qualified charities (i.e., they can’t make a stop in your personal checking account on the way). Third, each taxpayer is limited to $100,000 of QCDs per year (following the passage of SECURE Act 2.0 (read SECURE Act 2.0 - The Sequel), this limit will be adjusted for inflation beginning in 2024). And lastly, QCDs are allowed from IRAs, but not from 401(k)s, 403(b)s, TSPs, etc.
If you have already reached RMD age, which was just increased to age 73 for 2023, QCDs can help satisfy your RMD thereby lowering your taxable income. For instance, if your RMD is $50,000 and you make $10,000 in QCDs, only the net amount of $40,000 is included in your taxable income.
To dig a little deeper into how QCDs can impact taxes, let’s consider a married couple in their late 70s with RMDs who file their taxes jointly. Usually they report $30,000 of itemized deductions including $10,000 of charitable donations. In 2023, they decide to make $10,000 of QCDs directly out of their IRAs instead of making charitable gifts from their personal checking account. QCDs are not itemizable, so itemized deductions fall to $20,000, and they end up taking the $27,700 standard deduction instead. Compared to the year before, their taxable income is $10,000 lower and their deductions drop by only $2,300, all other things being equal. As with any tax planning strategy, we suggest discussing the idea with your tax preparer to weigh the benefits and costs of QCDs given your particular situation.
For some final logistical notes, QCDs are not identified on Form 1099-R, so you have to track them separately in order to properly exclude them from income on your tax return. Also, you should keep donor acknowledgement letters sent to you by the benefiting charities to substantiate your QCDs just as you would for other charitable gifts.
If you meet all of the requirements and are interested in making gifts to charity from your IRA, please contact us to discuss the mechanics and whether QCDs are right for you.
Read the February 2023 Financial Focus:
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