You are generous and you donate to worthy causes. Lately, you have been making long-term plans to continue giving when you retire, but you need to be strategic.
In the past, donations were given after income was received from retirement accounts, and this was an acceptable way to source the funds to contribute but after major changes in federal taxation, this is no longer tax efficient, and here is why:
Your IRA distribution generates income taxed at ordinary rates as high as 37%, and nowadays it is common to not have sufficient deductions to itemize. Your deduction for state income tax and property tax is limited to $10,000 and if your home is debt free, you do not have any mortgage interest to deduct; so your best opportunity to lower your tax bill is to donate to qualified charitable organizations.
The 2024 standard deduction for married couples is $29,200. If your deduction for state and local taxes is $10,000 you need to give at least $19,201 to benefit tax-wise by itemizing your deductions.
The workaround is to request a Qualified Charitable Distribution (QCD) from your IRA. If you are 70½ or older you can give up to $105,000 to charity, but let’s be realistic. Consider a married couple, with an IRA account holder at least 70½ years old, with a combined income of $120,000. Their budget for charitable giving is $15,000 and that’s generous.
They live in a home without a loan, their property tax and state income tax is about $10,000 and they donated $15,000 however they continue to file their tax return with a standard deduction year after year and feel they don’t receive any tax benefit from donating.
They called their financial advisor to discuss their concerns and were advised to instead give from their IRA using a QCD. Rather than a $10,000 per month IRA withdrawal, they receive $8,750 and their donations are sent out automatically every month from their IRA. Lower IRA distributions generate less taxable income, and this strategy saves them about $3,000 in federal income tax. It’s not much, but it’s enough to pay for a luxurious weekend trip to Scottsdale and relax.
While $3,000 is not a tremendous tax savings, higher income taxpayers that are not yet ready to establish a private family foundation may want to consider a QCD.
A QCD simply makes sense if you give generously and need to reduce your taxes, but let’s go deeper and consider these best practices and The Top Tip:
QCD Best Practices
You are required to have a letter from the organization or church to support the QCD and the letter needs to include “no goods or services were received”.
Early in the year, ask how much your required minimum distribution (RMD) is, and request QCDs from your IRA before you receive your RMD.
- Your QCD reduces your Required Minimum Distribution from your IRA.
- You cannot reverse an RMD to recharacterize the payment as a QCD.
Separate and organize your charitable donation records. Let your accountant know which donations were given through the QCD and which were given personally.
Charitable gifts, including QCDs, need to be made within a calendar year, so if you miss the December 31st deadline, you’re too late.
If you have or might have “basis” in your IRA due to contributing non-deductible “after-tax dollars” for retirement, make sure to have a discussion with your financial advisor before you request a QCD.
Only pre-tax IRA contributions, including the accumulated earnings within the IRA are eligible for a QCD.
The Top Tip
A long-term tax planning opportunity you should consider if your IRA has mostly non-deductible contributions and modest accumulated earnings is to donate the relatively lesser pre-tax dollars and income through QCDs and convert the remaining basis in your IRA to a Roth IRA.
- This strategy allows for generous donations from your IRA which otherwise would have been income.
- The Roth conversion will generate little to no tax if your QCD removed most if not all of the accumulated earnings and pre-tax contributions in your IRA.
- Roth IRAs have no RMD requirements, and that provides you with more control over the disposition of your retirement account.
