Are you a retiree? Do you give money to charity? You're almost surely doing it wrong. Let me explain. Do you know what a Qualified Charitable Distribution (QCD) is? If not, this post is for you! What if I told you that you could give to charity using pre-tax dollars, even if you don't itemize your deductions, and even if you don't want to hassle with a Donor Advised Fund, AND reduce the taxes due on your Required Minimum Distributions (RMDs) at the same time? Impossible you say? Likely to land you in jail? Nope. All perfectly legal, perfectly reasonable, and commonly done. Here's how it works.
What is a Qualified Charitable Distribution?
A Qualified Charitable Distribution (QCD) is money that is transferred directly from your tax-deferred account to a charity. Here are the key points:
- Tax-free to you (i.e. you never pay taxes on this money- it's triple tax-free like an HSA used for healthcare)
- Tax-free to the charity (they don't pay any taxes on it either)
- Counts toward the RMD for that year
- Cannot be more than $100,000
- Must go directly to the charity (you can't touch it like an IRA rollover)
- Must come out of a traditional or rollover IRA (not a 401(k), SEP-IRA or SIMPLE IRA)
- You must be 70 1/2 (not just turning 70 1/2 that year)
- Must be done during the calendar year (ideally check cashed by the charity by December 31st)
- Originally became possible in 2006, but eventually made permanent in 2015
- Cannot be used to donate to a Donor Advised Fund (DAF)
Nuts and Bolts
So what does this look like? Well, you fill out a form and ask the IRA provider to send a check directly to the charity and NOT withhold any taxes from the distribution. That's it. You did it.
So if your RMD for the year were $40K, and you were in a 22% tax bracket, and you wanted to donate $10K, you would send $10K to the charity and take $30K as your RMD, paying $6,600 (instead of $8,800) in taxes.
Why Are Qualified Charitable Distributions The Best?
So why is it that I think a QCD is the best way for a retiree to donate to charity? Well, let's look at the other ways and consider their problems.
# 1 Donate Directly and Deduct on Schedule A
With the new higher standard deduction, a retired couple, even one who gives $10K a year to charity, probably isn't going to itemize. So they get zero tax break for the charitable deduction. Essentially, they're doing it with after-tax dollars instead of pre-tax dollars. With a QCD, you can still take the standard deduction and pay with pre-tax dollars. Even if they are going to itemize, only part of their contribution is really pre-tax, since the first $24K in itemized deductions is basically free with the standard deduction. With a QCD, the entire thing is paid with pre-tax dollars. Plus, no need to keep receipts and haul them all into the accountant or enter them into Turbotax.
# 2 Donate Using a Donor Advised Fund (DAF)
DAFs were the cat's meow of the blogosphere in 2017, especially at the end. They have some niche uses, but have significant downsides such as ongoing management fees and the “jerk move” factor, where you get the deduction but the charity doesn't get the money. Most importantly, donations to DAFs have to be taken on Schedule A, just like a direct donation.
# 3 Donate Appreciated Shares
This is a great way to flush capital gains out of your portfolio. Not only do you get the charitable deduction for the entire value of the contribution, but neither you nor the charity has to pay the capital gains taxes on the appreciation between the time you bought the shares and the time you donated them. However, this is a tactic for the young, not the old. There might be some unique situation for a retiree where it could make sense to take your full RMD and donate appreciated shares to the charity instead, but I'm having trouble thinking of one since the ordinary income tax rates paid on the RMD are higher than the capital gains taxes on the gains of the taxable shares. Plus, a retiree is much closer to death, where the heirs get a step-up in basis. In addition, this deduction is taken on Schedule A, unlike a QCD.
As you can see, other than a few very niche kind of situations, the best method for anyone taking RMDs is a QCD.
Some Thoughts On Estate Planning
On a related note, if you plan to donate some of your nest egg to charity at your death, be sure that money comes from your traditional IRA or even better your HSA since it can't be stretched. Far better to leave the Roth IRA (tax-free and stretchable) or the taxable account (tax-free after step-up in basis) to your heirs. Meanwhile, neither you nor the charity pays taxes on the donation.
What do you think? Have you ever done a Qualified Charitable Distribution? Do you agree this is the best way for retirees to donate to charity? Why or why not? Comment below!