Charitably inclined? Consider making gifts earlier in the year.

Karen Van Voorhis, CFP |

Are you over age 70 ½, charitably inclined, and have a pre-tax IRA? Even better: do you have to take annual required minimum distributions (RMDs) that you don’t otherwise need for living expenses? If so, you may be a good candidate for qualified charitable distributions, or QCDs.

 

The QCD technique involves issuing a gift directly from a pre-tax IRA to a charity, instead of making that same gift from a checking, savings, or taxable investment account.

 

The benefits of QCDs include:

  • Reducing future taxable income, a future tax bracket, or future taxes due. This is because QCDs reduce the balance in a pre-tax IRA, which in turn decreases future RMDs. This may be part of a greater, multi-year tax planning strategy that involves keeping taxes low, or trying to reduce the size of pre-tax accounts to be passed to heirs (lest they be saddled with large mandatory taxable distributions, themselves).
  • Reducing current year taxable income, your current tax bracket, or taxes that will be due as a result of this year’s tax activity. This is because QCDs, if handled correctly, can count against the RMD required in the current year. Reducing this year’s tax liability can lead to other benefits, such as reducing the Medicare premium surcharge (IRMAA), or opening up the possibility of making Roth conversions (which are taxable).
  • Receiving the equivalent of a tax deduction for the gift, when you may not otherwise have received any tax benefit. This is because QCDs are distributed tax-free from a pre-tax IRA, and many charitable gifts no longer receive a tax deduction, given the huge increase in the number of people who take the standard deduction.

 

While we associate charitable gifts most often with November and December, if you would like to use QCDs, it’s important to think of this technique earlier rather than later if you will need to take an RMD this year. For example, let’s say that your RMD this year is $25,000, and you also plan to give $5,000 to charity. If you fulfil your RMD first, and then want to give $5,000 from your IRA to charity, you can definitely do that - but that $5,000 gift won’t count against your RMD (because it’s already been taken), and you will be taxed on the full $25,000 distribution. If, on the other hand, you implement a QCD of $5,000 before taking any funds from your IRA, you will only be obligated to take the remaining $20,000 to fill your RMD requirements.

 

Qualified charitable distributions can be a component of a more comprehensive, years-long tax strategy. Let your financial planner know if you would like to make charitable gifts, so that he or she can help you come up with the most effective strategy, and so that there aren’t any missed opportunities.