Many retirees with IRAs or 401(k)s face a common problem once they reach their early 70s: how to handle required minimum distributions (RMDs). RMDs are the IRS’s way of requiring those who have accumulated tax-deferred funds in traditional IRAs or qualified plans to take a calculated distribution and pay taxes on it. For some, the funds are needed to cover living expenses, so RMDs are no problem. However, for others, the family will not need the money. What makes RMDs challenging in this case is that the withdrawal is required regardless of need. Failure to take this RMD can result in a heavy penalty. This leaves many retirees looking for ways to avoid paying taxes on money they don’t need.
For clients with charitable inclinations and legacy goals, there is a strategy that satisfies both aims while also covering part or all of an RMD. Upon reaching age 70½, the IRS allows an individual to make qualified charitable distributions (QCDs) directly from an IRA. A QCD sends funds straight from the IRA to a charity, without the money ever passing through the account owner’s hands. Each individual can give up to a total of $111,000 to a nonprofit of their choice, or divide that amount between several organizations.
There are a few advantages to making a QCD compared to a standard charitable gift and deduction. Standard charitable gifts qualify for an itemized deduction, but to get any benefit from this at all, a taxpayer’s itemized deductions must outweigh the standard deduction. Otherwise, the most a taxpayer can deduct is $1,000 single or $2,000 married filing jointly. Even for a taxpayer who itemizes, the tax savings amount to roughly their marginal tax rate in cents on the dollar. Taking the RMD adds every dollar of that distribution to adjusted gross income, and the taxpayer only recovers a fraction of it back through the deduction. The advantage of a QCD is that the distribution is never added to a taxpayer’s taxable income in the first place. Per dollar, this has the potential to save a taxpayer much more than taking the RMD and donating to a charity afterward. Furthermore, a QCD will fulfill part or all of a taxpayer’s RMD. For example, if an IRA owner’s RMD is $40,000 and they direct $20,000 to a QCD, they only have to take the remaining $20,000 as an RMD and include it in their income.
For IRA or qualified plan owners who do not need the money from their IRA, want to avoid taxes on RMDs, and have charitable wishes, this can often be the most tax-advantageous way to fulfill those charitable goals.
It is important to consult with a financial advisor and a tax advisor before making these decisions, to confirm that a certain level of donation is affordable and that it is, in fact, the most tax-advantageous method to give. Every family’s situation is different, so it is
worth taking the time to understand your own. Boyce & Associates is happy to help with that conversation.
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This blog contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this blog will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Boyce & Associates does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.
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