Brandon Carter, CFP®, CIMA®, ChFC®, AEP®, MSFS
In my opinion, qualified charitable distributions (QCDs) are one of the most underutilized tax strategies around today. Those who qualify and are already giving to charity often get more tax savings with little to no downside. In this article, I will go through some basics of QCDs and three ways they can save a taxpayer money.
What is a QCD?
The year you turn 70½ years old, you must take a required minimum distribution (RMD) from your traditional IRA accounts. Distributions from these accounts are typically taxable unless your RMD is done as a qualified charitable distribution. QCDs are non-taxable direct transfers out of a traditional IRA, by someone 70½ or older, to a qualified charity. Although many use QCDs to satisfy their RMD it is important to note that they are not limited by required distributions. The annual maximum QCD amount per individual is $100,000. (For related reading, see: Top Tips to Reduce Required Minimum Distributions.
One of the common questions I get about QCDs is: “How is giving my required distribution (or part of my RMD) as a direct transfer through a QCD different than receiving my required distribution and then giving it to a charity?” They are different for multiple reasons. One of the main differences has to do with the location and the way each is recorded on your tax return. To make a long story short, the amount of a traditional IRA distribution received directly and later given to a charity increases your combined, adjusted gross and modified adjusted gross incomes. Qualified charitable distributions do not increase any of these.* I will elaborate on this and a few other differences as I go through the three ways QCDs can save you money.
1. Taxes on Social Security Benefits
If you are not taxed or you are only partially taxed on your Social Security benefits, a QCD could help keep it that way. Similarly, if you are being taxed on your Social Security benefits, using a QCD could reduce the amount of taxes you own on those benefits. Whether you are taxed on your Social Security benefits or not is based on your “combined income.” Combined income is your adjusted gross income + non-taxable interest + half of your Social Security benefits. If your combined income is below $25,000 for single filers or $32,000 for joint filers, you pay no federal income tax on Social Security benefits.
As discussed above, receiving a distribution directly from your traditional IRA then giving it to charity would increase your combined income and could cause your Social Security benefits to be taxed or taxed more. The amount of your distribution done as a QCD would not increase your combined income and, therefore, would not cause your Social Security benefits to be taxed. (For related reading, see: Give to Charity, Slash Your Tax Payment.)
2. Savings on Medicare Part B Premiums
The amount you pay for your Medicare Part B premium is based on your modified adjusted gross income (MAGI) two years ago. The higher your MAGI, the higher your premium will be. At the lowest income threshold ($85,000 single filer or $170,000 joint), premiums are $134/month and at the highest ($214,000 single filer or $428,000 joint) they are $428.60/month. Like number one, receiving a distribution from a traditional IRA and then giving it to a charity increases your MAGI. However, the amount of the distribution done as a QCD does not. For more information on income and Medicare premiums check out Medicare's 2017 costs.
3. Income Tax
QCDs can reduce your income taxes particularly if you don’t itemize deductions or if your charitable contributions are what cause you to itemize. Tax savings from charitable contributions are realized only when you itemize deductions. Many tax payers over 70½ years old take the standard deduction rather than itemize. That means they would not receive a tax benefit for taking their required distribution and then giving it to charity. A QCD, on the other hand, would allow these same taxpayers to transfer funds from their traditional IRA directly to their favorite quailed charity, satisfy their required distribution and not increase their tax liability. It is a no-brainer if they were going to give to that specific charity anyway.
This article is not a comprehensive list of the benefits of QCDs, but hopefully it was helpful to you. In summary, if you qualify for a qualified charitable distribution and are giving to a charity anyway, why not take advantage of the QCD? With that said, everybody’s situation is different and I would encourage you to work with a qualified tax advisor. If you are not taking advantage of QCDs and think it may make sense for you, ask your tax advisor about it.
*The amount of a QCD is not considered taxable income on your tax return. The QCD amount shows up in line 15a of the 2016 form 1040 but is not included as a taxable distribution in line 15b. When you receive an IRA distribution directly and give it to a charity, the distribution is added to your tax return on line 15a of the 1040 as a taxable distribution and then taken off farther down as a charitable contribution. In summary, what this means is that distributions done as a QCD are not considered when calculating your adjusted or modified adjusted gross income. (For more from this author, see: Top 3 Mistakes Retirees Make With Their Finances.)
The commentary in this article reflects the personal opinions, viewpoints and analyses of Brandon Carter, and should not be regarded as a description of advisory services provided by Financial Strategies Group, INC or performance returns of any Financial Strategies Group, INC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this article constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Financial Strategies Group, INC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.