By Christian Cordoba, CFP
For more than a decade, qualified charitable distributions (QCDs) have
been a staple of tax-efficient philanthropy for seniors. The current rules
are better than ever, thanks to a quirk in tax law, but that tax law opportunity
vanishes in January 2022.
Acting this year can be a savvy strategy. Here’s the story:
Generally, distributions from a traditional (pre-tax) IRA are included
in gross income, subject to tax. The prime exception is a QCD, which goes
directly from an IRA to a qualified charity. QCDs don’t provide
a tax deduction, so why make donations this way?
Because QCDs enable IRA owners to move money from a tax-deferred retirement
account without owing tax. QCDs aren’t included in gross income,
regardless of how much money a taxpayer reports. Holding down adjusted
gross income (AGI) may have many benefits on a tax return.
The 100% solution
To understand the possible advantage of using QCDs this year, it’s
vital to know a tax break is about to expire. Generally, deductions of
cash donations are limited to 60% of AGI – for example with an AGI
of $120,000, cash contributions of $72,000 are tax-deductible.
However, COVID-related legislation raised that limit to 100% of AGI through
12/31/21. It reverts to 60% of AGI effective 1/1/22, so the following
strategy has emerged:
John and Mary Smith wish to support a favorite charitable recipient, such
as Torrance Memorial Medical Center, with a donation of $500,000. They
decide to use QCDs for the maximum allowed - $100,000 per person per year.
John and Mary each direct their IRA custodians to move $100,000 from their
individual IRA accounts to Torrance Memorial before the end of 2021, for
a total of $200,000. Additionally, John transfers another $300,000 from
his IRA completing the $500,000 gift.
The $300,000 is added to John’s AGI, but under the 100%-of-AGI provision
described above, the Smiths can deduct all $300,000 on their tax return,
as an itemized deduction, if they have a larger AGI. With this approach
the couple has made the $500,000 donation they wanted, moved $500,000
of pre-tax money from their IRAs without raising their tax bill, satisfied
their required minimum distributions (RMDs) and freed up cash they didn’t
need to use for their charitable contribution.
Still 70½. . .not 72 for QCDs
Besides the $100,000 annual limit on QCDs, IRA owners must be at least
age 70½ to qualify for the QCD option. The Secure Act of 2020 raised
the age for RMDs to begin from 70½ to 72, so the QCD option can
actually be used before RMDs take effect.
That said, QCDs are especially attractive for taxpayers who must take RMDs.
QCDs satisfy the annual RMD, and they do so without adding to the IRA
owner’s taxable income. Using QCDs is an excellent way for people
taking the standard deduction to get a tax benefit (a lower AGI), even
though they’re not itemizing deductions.
Sooner than later
Something to consider in your planning is the tax code contains a trap
for QCD users. Each year, the first dollars taken from an IRA are considered
to satisfy RMDs, so it’s wise to begin making QCDs early in the year.
For example, suppose Nancy Jones has a $35,000 RMD for 2021. Early in the
year, she took $20,000 from her IRA which was applied to her RMD. In December,
she sends $35,000 to Torrance Memorial as a QCD. She has fulfilled her
RMD, but she will increase her AGI by $20,000 taken early in the year.
Had she made her $35,000 QCD to Torrance Memorial early in the year, she
could have avoided adding $20,000 to her AGI.
Even though the 100%-of-AGI remains a viable year-end tactic for 2021,
IRA owners should begin making their 2022 QCDs early next year to avoid
being snared by this tax trap.
The IRS answers frequently asked questions about QCDs at
Retirement Plans FAQs regarding IRAs Distributions Withdrawals | Internal
Christian Cordoba is a CERTIFIED FINANCIAL PLANNER™ and Founder of
California Retirement Advisors. He is a member of Torrance Memorial’s
Professional Advisory Council. firstname.lastname@example.org. (888) 643-7472.
Investment advisory services offered through Mutual Advisors, LLC DBA California
Retirement Advisors, a SEC registered investment adviser. Securities offered
through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities,
Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license
#0B09076. The information presented is not to be considered advice you
can or should act upon for investment, tax or estate planning purposes
without consulting with a professional to discuss your own set of unique
circumstances. This article is designed to provide you with information
regarding investing and planning for or during retirement.