As individuals invest in their retirement funds, over the years these accounts can become one of the largest assets at the time of retirement. At age 70 1/2, you must begin to take Required Minimum Distributions ("RMD") from these accounts based on your life expectancy. These income distributions are taxable and can cause an individual to move into a higher tax bracket or increase their Medicare premium expenses.
A great way to offset some of this taxable income is to use a portion of your IRA RMD to donate to qualified charitable 501(c)(3) organizations ("Qualified Charities"). These donations are called Qualified Charitable Distributions ("QCD").
How To Make A QCD: To make a QCD, the funds must go directly from your IRA to a Qualified Charity. At your request, your IRA administrator will make a distribution directly to the Qualified Charity to satisfy your RMD. At tax time you will receive a 1099-R from your IRA showing the full amount of your distribution. Your tax preparer will then enter the amount of the RMD that went to Qualified Charities through a QCD. The QCD will reduce the taxable portion of the 1099-R.
Example: Lisa is 72 years old, lives on a combination of $25,000/year of Social Security and another $25,000/year of interest income from her portfolio, and has a $3,400 RMD this year. In addition, Lisa donates each week to her church and takes the deduction on her Schedule A to offset the tax consequences of her RMD. She would like to assess the tax savings benefit if she simply did a Qualified Charitable Distribution directly from her IRA to the church to satisfy her RMD obligation.
By allocating Lisa's RMD to a QCD, her AGI would result in $25,000 (ordinary income) + $7,475 (the taxable portion of her Social Security) = $32,475. Since Lisa has only $6,000 of itemized deductions, she instead claims the $7,850 standard deduction (including the additional amount for being over age 65), and also receives a $4,050 personal exemption, which brings her taxable income down to $20,575. Based on the 2016 individual tax tables, this puts Lisa in the 15% tax bracket, with a total tax liability of $2,622.50.
In contrast, if Lisa were to take the $3,400 RMD directly, her income would increase by $3,400. In addition, the higher income would also increase the taxability of her Social Security from $7,475 to $10,365. The subsequent $3,400 donation to her church would produce a $3,400 tax deduction, bringing her total tax deductions to $9,400 (although she already had a $7,850 standard deduction, only the last $1,550 produces any tax savings). Thus, Lisa’s final taxable income is $38,765 – $9,400 – $4,050 = $25,315, which produces a tax liability of $3,333.50.
Benefits: The bottom line for Lisa is the saving in taxes of $711 by simply allocating the deduction straight from the RMD instead of receiving the RMD herself. Depending on your income, you may also avoid the Medicare high-income surcharge, which increases your Part B and Part D premiums based on your AGI.
Tips for QCDs: To make a QCD, we recommend contacting the charitable organizations first to obtain the correct address and mailing information to make your gift. You will then need to obtain an application from your financial planner or IRA Administrator to make an RMD distribution by checking the QCD box (with no taxes withheld) and provide the information for the charitable organization. The application should have your name and address on it so the charity knows who to send the acknowledgment letter to and state that no goods or services were received for the donation. Any donations over $250 require a written receipt from the charity. Come tax time, provide the 1099-R along with the QCD information to your tax preparer.
If you have any questions about Qualified Charitable Distributions and other tax planning, please feel free to contact Glick and Trostin, LLC at 312-346-8258.
Disclaimer: The materials on this website are provided for informational purposes only and do not constitute legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between any attorney and any other person, group or entity. No representations or warranties whatsoever, express or implied are given as to the accuracy or applicability of the information contained herein. No one should rely upon the information contained herein as constituting legal advice. The information may be modified or rendered incorrect by future legislative or judicial developments and may not be applicable to any individual reader's facts and circumstances.
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