As we approach the tax filing deadline this year, April 18th, many fear the outcome. I have yet to meet anyone that likes to pay income tax. For those of you who want to give back to your communities, you may be able to benefit financially by reducing your income taxes.
We will focus on charitable giving utilizing a qualified charitable distribution (QCD).
Requirements for a Qualified Charitable Distribution (QCD)
1. You are 70 ½ or older when you do the QCD. If you make a QCD before turning 70 ½, the distribution will be taxable income.
2. You are charitably inclined.
3. You have an IRA, SEP IRA (not receiving contributions), or SIMPLE IRA (not receiving contributions).
Also, a beneficiary of an inherited IRA is eligible to do a QCD once they attain age 70 ½
If you meet these requirements, you can donate up to $100,000 in a calendar year to a charity of your choice, as long as it is a non-profit organization under tax code 501(c)(3). You can choose several charities as well.
Benefits of QCDs
Now, let’s focus on how this can benefit you.
Giving to charities and knowing you are helping make a difference is very rewarding for many. Reducing your tax bill is also very satisfying for everyone. A donation using a QCD is not included in your taxable income. Reducing your income is much more favorable than getting a tax deduction.
QCD Additional Rules
- The funds must be transferred directly from your IRA custodian to the qualified charity. Request your IRA custodian to issue a check from your IRA payable to the charity. Most of our clients request that the check gets sent to them and forwarded to the charity. If a distribution is paid to you, it will not qualify as a QCD and is included in your taxable income.
- In the year you turn 72 and are required to take a required minimum distribution, to qualify as a QCD, these distributions must be the first funds out of your IRA. You can make a QCD in excess of your RMD as well.
- Contributing to an IRA may result in a reduction of the QCD amount you can deduct.
Example Scenarios for QCDs
Let’s go through a few scenarios:
Example 1
Charlotte is turning 70 ½ this year. She will be 70 ½ on June 18th, 2022. Charlotte has an IRA and requests a distribution of $20,000 payable to the American Heart Association on April 10th, 2022.
This will not qualify as a QCD because she made this transfer before turning 70 ½. The $20,00 will go to the American Heart Association but will not qualify as a QCS; therefore, the $20,000 will be taxable income.
Example 2
Richard is 72 and must take a $52,000 withdrawal to satisfy his 2022 RMD. He takes the distribution in mid-January, withholds taxes, and deposits the balance into a non-qualified account invested in Bitcoin.
Richard has been following the Russia Ukraine crisis and wants to assist Ukrainian refugees. He is somewhat familiar with QCDs and knows that if the distribution comes from his IRA, the distribution will reduce his taxable income. He has decided to reverse his RMD and ask the IRA custodian cut a check payable to UNICEF, a non-profit organization under tax code 501(c)(3).
Upon making this request, Richard was informed by his IRA custodian that an RMD could not be reversed. However, the custodian mentioned, he could still make a donation payable to UNICEF, which would qualify as a QCD and reduce his taxable income by whatever amount he donated up to $100,000.
Although Richard wanted to assist Ukrainian refugees, he did not want to take more out of his IRA this year. His IRA had dropped 10%, and his one share of Bitcoin was down 9% since he purchased it.
Note: Since Richard did not want to take any more out of his IRA than was necessary, his RMD or part of it should have been payable to UNICEF, resulting in an income reduction of $52,000. To have the RMD paid as a QCD, the QCD has to come out of the IRA first. Richard could have still donated to UNICEF from his IRA, which would qualify as a QCD, but he declined.
Example 3
Jennifer has reached age 70 ½ in February 2022. She makes a QCD of $10,000 to Habitat for Humanity in March 2022.
Later that month, Jennifer made a $7,000 deductible IRA contribution. Unfortunately, the tax-free portion of the $10,000 QCD is reduced by the $7,000 deductible IRA contribution, resulting in only a $3,000 reduction to her income. The remaining $7,000 is taxable to her.
What If I Want to Do a QCD, But My Plan Does Not Allow It?
Remember that you cannot do a QCD from a TSP, 401(k), 403(b), or a 457(b) plan. If you want to take advantage of a QCD, you need to roll over to an IRA.
You may want to consider rolling some of your TSP to an IRA if you qualify and are interested in doing a QCD. Your first reaction is probably: The TSP fees are lower than any investment I can get in an IRA.
That is not the case. All the index funds except the G fund are available outside of TSP from Vanguard, Charles Schwab, Fidelity, and many other custodians. I will tell you that Fidelity has lower expenses than TSP. For example, the C fund represents the S&P 500 index and comes with a meager expense ratio of.043%. The S&P index from Fidelity comes with an even lower expense ratio of .015%. I want to clarify that I don’t work for Fidelity and do not get any compensation from Fidelity.
During the distribution phase of your life, an IRA may be a better option that provides more flexibility. Another reason is if you want to choose what fund or index you want to take distributions from, you can specify that in most IRAs, whereas in TSP, all distributions come out proportionately.
Suppose you decide to transfer TSP to an IRA. In that case, I always recommend leaving some funds in there for two reasons: (1) the G fund is only available in TSP and (2) if you ever decide you would like to transfer your IRA back to TSP, they will allow it as long as your account value is not below $200. I don’t necessarily recommend index mirroring the TSP funds in an IRA during the distribution stage, but I wanted to inform you that it is available.
Tax Filing for QCDS
QCDs get reported as a normal distribution on IRS Form 1099-R for any non-Inherited IRAs. It is your responsibility to notify your tax preparer of the amount of the QCD so they can include this on your tax return. If you prepare your tax return, the instructions for reporting the QCD can be found on form 1040.
Extra Perks
- QCDs can be a tax-efficient way to make charitable contributions.
- QCDs can help reduce future RMDs.
- Charitable giving may be very rewarding.
- These distributions can help retirees manage their AGI levels each year.
- QCDs can mitigate other “stealth” taxes based on AGI, such as net investment income and Medicare Part B surcharges.
