Qualified Charitable Distribution (QCD): How it Can Reduce Taxes

There are many ways to give to charity such as by writing a check, purchasing tickets to an event, or even donating physical goods. In many cases, a portion (or all) of these contributions is also tax-deductible. However, if your objectives are to disperse money to charity and act with tax efficiency in mind, a better approach may exist via a qualified charitable distribution (QCD).

An overview of QCDs

A QCD is a direct transfer of funds from your IRA—payable directly to a qualified charity—as outlined in the Internal Revenue Code. The qualified charitable distribution rule allows owners who are at least 70½ years old to transfer up to $100,000 from their traditional IRA account to charity on an annual basis. Beginning in 2024, the limit of $100,000 will be indexed for inflation: meaning you can potentially contribute more in the future.

How QCDs are utilized

QCDs are often used to satisfy some (or all) of your required minimum distribution (RMD) requirements while reducing your taxable income.

If you’re currently unaware, RMDs reflect the minimum amount of money one must withdraw from specific tax-deferred retirement accounts beginning at age 73 (age 75, starting in 2033). RMD rules apply to various employer-sponsored retirement plans including 401(k), 403(b), profit-sharing, and 457(b) plans. The mandate also applies to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, SIMPLE IRAs, and Roth IRAs (following the owner’s death).

Those impacted must take their RMDs by December 31 of each year (although you do have a few options regarding your initial RMD, which you can read about here).

The most significant QCD benefits are tax-related: unlike regular RMD withdrawals, qualified charitable distributions are excluded from your taxable income and can prevent some people from moving into higher tax brackets.

As a result, QCDs can potentially help taxpayers maintain eligibility for specific tax credits/deductions and avoid exposure to various Medicare surcharges and Social Security taxes. For others who don’t need to rely on RMDs because they’re living on other sources of income, a QCD can also help them avoid the 25% penalty that’s imposed if they don’t take their required minimum distribution.

Furthermore, QCDs can also reduce the amount of taxable money for IRA owners who wish to convert their tax-deferred account balances to a Roth IRA account.

Giving more (or less) than your RMD

You can use QCDs to satisfy all or part of your RMDs: meaning you can use less than your full RMD for a charitable distribution if you wish to do so. However, you’d still need to take a regular RMD withdrawal for the remaining amount. For example, if your RMD is $5,000 and you only wish to give $2,500 to charity, you’d also take out $2,500 as a standard RMD withdrawal.

Conversely, you can exceed your RMD requirements for a given year (up to $100,000) for QCD purposes but cannot carry over the extra distribution to meet RMD obligations in future years.

How to qualify for the QCD rule

As stated earlier, you must be at least 70½ years old to take advantage of the qualified charitable distribution rule. Therefore, if you own an IRA and turn 70 on April 30th, you cannot make a QCD until October 30th of that same year.

You must also transfer funds from an IRA (traditional/inherited IRAs and inactive SEP and SIMPLE IRAs are eligible) rather than an employer-sponsored retirement account such as a 401(k).

What’s more, you must transfer these funds directly to a qualified charity: generally one that is a 501(c)(3) and thus authorized to receive tax-deductible contributions (consult with your tax advisor or the IRS to ensure the charity is IRS-approved). The charity must also substantiate the donation amount with a written receipt.

Finally, QCDs must also meet the same deadline as a regular RMD distribution—usually December 31st of each year.

Other qualified charitable distribution considerations

Regardless of whether you plan to itemize your charitable contributions or take advantage of the recent tax changes and claim a standard deduction (currently $13,850 for single filers and $27,700 if married and filing jointly) on your next tax return, a QCD is sometimes beneficial in either scenario. Just know that if you decide to itemize, you can’t also itemize your QCD: as this would result in a double tax break since you are already reducing your taxable income.

Meanwhile, married couples filing jointly who each have their own IRA can both take advantage of the QCD rule: meaning you can each donate up to $100,000 per year to the eligible charities of your choice.

You can also make contributions to as many charities as you wish, provided their sum doesn’t exceed the annual limit. No matter how many charities you help, keep in mind that you must transfer money directly to the charity from your IRA account. You are therefore not allowed to use a QCD to purchase charity sales items such as raffle tickets or auction bids, nor can you receive any type of benefit in your charitable donation return for your QCD to qualify.

Under the Secure Act 2.0—which passed into law in December 2022—an IRA owner can now make a one-time election to use a QCD to fund a split-interest entity (generally an account wherein contributions are shared by multiple beneficiaries, including a nonprofit organization). The limit in this case is $50,000 and can be used for a charitable remainder unitrust, charitable remainder annuity trust, or charitable gift annuity.

It is also possible to use Roth IRAs for qualified charitable distributions; however, since these aren’t subject to RMDs and distributions are generally tax-free, owners will not see any corresponding benefit.

Finally, inform your accountant that you completed a QCD (ideally through your IRA custodian, who’ll send you a 1099 form) and keep the donation receipt for your tax records.

In sum: what to know if you’re considering a QCD

If you’re looking to reduce your adjusted gross income, lower your taxes, and give to charity, a qualified charitable distribution is often a viable option: provided you’re about to begin (or have already started) taking RMDs and also possess an IRA account.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.