QCDs: The Charitably-Minded IRA Owner's Best Friend
This time of year, the email inboxes of generous donors fill with last-minute requests from charities to "support the mission" and "make a year-end gift." But before writing that check, pause to consider the best way to gift to charity. As discussed last week, giving appreciated stock rather than cash is one tax-savvy option. For owners of Traditional IRAs who regularly support charitable organizations, the Qualified Charitable Distribution (QCD) is another gift option that provides more significant tax savings than cash donations. In addition to lowering your tax bill, using QCDs can help maximize your charitable impact.
Maximize Your Charitable Impact
Beginning at age 70.5, IRA owners can take tax-free distributions from their Individual Retirement Accounts to make charitable gifts. While RMDs are not required until age 72, this giving approach will enhance your tax savings while increasing your charitable impact. The QCD gifting option allows IRA owners to direct up to $100,000 per year in IRA distributions to qualified 501(c) non-profit organizations. The IRA distribution goes directly to charity, and therefore the IRA owner does not need to report the QCD as taxable income. Clients who custody their assets at Schwab can request a charitable checkbook. Check writing can make giving weekly or frequent smaller contributions much easier.
Enhance Tax Savings By Reducing AGI
Taxpayers who make QCDs receive tax benefits from charitable donations even if they do not itemize deductions because taxable income excludes the amount of your QCD. In general, when taking money out of a Traditional IRA, you have to pay income tax on those distributions because you made contributions with tax-deferred income. Typically, IRA custodians withhold taxes on IRA distributions and provide account holders with Form 1099-R to complete their tax returns. Those distributions increase ordinary income while making QCDs reduces Adjusted Gross Income (AGI). Reducing AGI generally provides a more significant tax benefit than claiming a tax deduction because the IRS uses AGI in several other calculations. For example, AGI determines the taxable portion of your Social Security benefits and other income-related tax deductions and credits.
As an example of the potential tax savings of a QCD, consider a hypothetical donor. "Joan" is a 73-year-old widow and this is the first year she will file an individual tax return as she was married for almost 50 years. Her husband's pension paid her $35,500 in ordinary income in 2021 and she had $30,000 of Social Security income. She also inherited his IRA and rolled it into her own IRA account. The IRA balance on December 31, 2020 was $1,000,000. Calculating her required minimum distribution using the Schwab calculator, she knows she must take a distribution of $40,485.83. Joan does not need that money and would like to give it to charity. The chart below compares her cash gift $40,486 with a QCD for $40,486.
|Cash Gift (including RMD)||QCD Gift (excluding RMD)|
|Joan’s Adjusted Gross Income Including vs. Excluding $40,486 RMD. Both examples assume $35,500 pension income and $30,000 Social Security income.||$101,485||$54,025|
|Charitable Donation Amount Assumes donation is to qualified public charity||$40,486||$40,486|
|Itemized or Standard Deduction When Filing Income Taxes Cash Gift scenario assumes gift is only itemized deduction QCD Gift scenario assumes 2021 standard deduction amounts: $12,550 plus $1,700 for additional standard deduction||$40,486 itemized deduction||$14,250 standard deduction|
|Estimated Federal Taxable Income||$60,999||$39,775|
|Taxable Social Security||$25,500||$18,525|
|2021 Estimated Federal Income Taxes owed based on 2021 tax rate/brackets and standard deduction. Excludes other federal and state income taxes.||$9,018||$4,424|
|Cash vs. QCD Gift—Estimated Tax Savings||$4,594|
Joan saved almost $4,600 in taxes through her qualified charitable donation in the example above. The money had to come out of her IRA to avoid a steep penalty (50% of the RMD amount), and in this way, she was able to support causes near and dear to her heart.
If you are unsure about the best gifting method for your tax situation, please feel free to reach out to Hurlow Wealth Management Group. Our financial advisors have helped clients plan charitable giving strategies for nearly two decades. Click here to schedule an introductory call to see if our services are right for you.