If you have a traditional Individual Retirement Account (IRA), you must start withdrawing some of the money at a certain age. That age has been adjusted several times, but as of Jan. 1, 2023, it's the year you turn age 73.
This is a non-negotiable rule and the penalty is hefty.
Why? Because you haven't paid income taxes on that money yet, and the Internal Revenue Service (IRS) wants its cut. The money taken out is then taxed at the ordinary income tax rate. As such, the withdrawals can cause a problem because they can boost your annual income—sometimes into a higher tax bracket.
But there’s a way that you can put these distributions to good use and reduce your tax burden. Given the impact that RMDs can have on your tax bill, it’s worth creating a long-term planning strategy around this rule.
- The qualified charitable distribution (QCD) rule allows traditional individual retirement account (IRA) owners to deduct their required minimum distributions (RMDs) on their tax returns if they give the money to a charity.
- The rule can effectively reduce your income taxes by lowering your adjusted gross income (AGI).
- The amount is capped at $100,000 annually per person.
- The money must be paid directly to an approved charity.
- If you donate a portion of your RMD, you must take the remaining distribution amount yourself.
Who Can Use the Qualified Charitable Distribution (QCD) Rule?
Congress made the qualified charitable distribution (QCD) a permanent rule in 2015. It allows owners of a traditional IRA to exclude RMDs from their adjusted gross income (AGI) if they give the money to an approved charity, also known as a qualified charitable organization.
The QCD rule allows you to give the amount you donate from your IRA directly to charity without ever receiving it as income. That enables you to give the full amount you withdraw to charity rather than what's left after you pay the individual income tax due on the funds you took out.
Best of all, you can start taking QCDs at age 70½; you don't have to wait until you hit 73.
It gets better when you reach 73, the age at which you now have to begin taking RMDs. QCDs count as part of your annual RMD amount. Thus, if you are at least age 73, you can use the QCD rule to exempt your RMDs from taxation.
You can choose to make full or partial RMD distributions to charities. For example, if your RMD amount is $5,000 a year, you can make a $3,000 charitable distribution and take the remaining $2,000 yourself, paying taxes just on $2,000. Or, you can give the full $5,000 to charity if you choose to do so, and owe no taxes on your RMD for that year.
Here’s how it works. Once you decide to make a QCD, choose a charity and make sure it qualifies as a charitable organization under Internal Revenue Service (IRS) rules. You must let your IRA custodian know of your intentions and the amount so it can cut the check to the charity on your behalf. The investment firm then sends the check to the organization or to you, for you to send to the charity.
QCDs must be made directly from your IRA. You'll lose the deduction if the money is paid to you and then passed on to a charitable organization.
All contributions and earnings that accumulate within a traditional IRA are eligible for QCDs. The IRS caps the amount that you can donate each year as a QCD directly from your IRA at $100,000. Anything in excess of this amount must be taken as an itemized deduction.
A QCD reduces your AGI, a benefit to a taxpayer at any age. However, you cannot claim a QCD gift as a tax deduction on your annual tax return.
The exception is nondeductible contributions, as they are considered a tax-free return of basis. Joint gifting strategies are also ineligible for the purpose of QCDs, which means that a couple cannot take both of their aggregate RMD amounts from a single account and exclude the entire amount from their AGI. Each of them must take their RMD from their own account for both to qualify.
The QCD strategy can also benefit traditional IRA owners who want to convert their balances to Roth accounts, as the QCD will reduce the amount of taxable money in the account.
The IRS offers a searchable database of approved charities on its website.
The AGI Advantage
You can generally take an itemized tax deduction when you donate money to a 501(c)(3) charitable organization, which reduces your AGI. Keep in mind, though, that you must have enough deductions to make itemizing worthwhile.
For 2022 taxes, you need to have at least $13,000 for single filers (or $26,000 for married couples filing jointly) in deductions to benefit from itemizing since the standard deduction in 2022 is $12,950 for single filers and $25,900 for married couples filing jointly. In 2023, the standard deduction increases to $13,850 for single filers and $27,700 for married couples filing jointly.
The QCD rule offers you a way to reduce your AGI through a charitable donation without having to itemize your deductions. Because AGI is used for many tax calculations, having a lower number allows you to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security or other income, and still remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income.
The age for taking required minimum distributions (RMDs) has been raised to 73 from 72 as of Jan. 1, 2023. That’s for withdrawals from traditional IRA and 401(k) accounts as well as SIMPLE and SEP IRAs. (Roth account owners aren’t subject to RMDs.) The penalty for failing to make an RMD has also been lowered but it’s still very severe at 25% of the remaining balance in the account.
Should I Use the QCD Rule?
The main rule about QCDs is that the distributions must be made directly to the charity, not to you. This means that the check must be made out to the charity. If it isn’t, it is counted as a taxable distribution.
You can receive the check and send it on to the organization, but you can’t deposit the check and make out another one to the charity. The donation amount must be substantiated by the charity with a written receipt.
But the question remains: Should you use the rule? It depends on your situation. Using the rule makes sense if you:
- Don’t need the money or it would put you into a higher tax bracket.
- Want to lower your RMD amount in future years.
- Want to support an approved charity rather than a foundation or donor-advised fund (which don’t qualify as charitable organizations).
- Want to make a larger donation than you could in cash.
There are cases in which an IRA RMD can't provide the best benefit as a charitable donation. Donating securities like stocks provides a greater tax benefit to you if they had appreciated in value since the time of purchase, as you won’t have to pay the capital gains.
Keep in mind that you may use the QCD rule for distributions from a Roth IRA. But doing so doesn’t provide you with any tax benefit, as your distributions are already tax-free. What's more, RMDs are not required from Roth IRAs.
What Is the Benefit of a Qualified Charitable Distribution (QCD)?
A qualified charitable distribution (QCD) can lower your adjusted gross income (AGI) while also satisfying the required minimum distribution (RMD) rules set by the Internal Revenue Service (IRS). This can help offset other taxes, such as Social Security.
When Can I Make a QCD From My Individual Retirement Account (IRA)?
You can make a QCD from your individual retirement account (IRA) whenever you would make any other withdrawals, which is to say that you can make a QCD anytime once you reach the age of 70½.
How Do I Report a QCD on My Tax Return?
You report the full amount of the QCD on the line for IRA distributions. On the line for the taxable amount, enter zero, then write “QCD” next to it. IRS Form 1040 has additional information.
The Bottom Line
If you own a traditional IRA and want to lower your adjusted gross income for tax purposes, you can use the QCD rule to donate to a charity of your choice, as long as you've reached age 70½.
If you use this strategy, don't take the distribution yourself and then donate it to charity. Have it sent directly to the charity. If used properly, the QCD rule will get you a handy tax deduction for years to come while fulfilling your philanthropic goals.