Qualified charitable distributions can ease the tax pain of RMDs
Can a non-deductible charitable contribution save taxes?
Possibly, once clients reach age 70 1/2. Subsequently, seniors can make qualified charitable distributions directly from individual retirement accounts to charity, up to $100,000 per individual per year.
“We have clients who have used QCDs,” says Jim King, a CFP and the president and founder of J.P. King Advisors, a financial planning and investment advisory firm in Walnut Creek, Calif. “When I reach the required age, I plan to use a QCD myself.”
Explaining the advantages of QCDs to clients may be challenging, as they don’t provide a charitable tax deduction. So why bother?
The key lies in the age threshold of 70 1/2, which is when required minimum distributions from traditional IRAs begin. QCDs count as RMDs.
Thus, if John Smith has a $25,000 RMD this year but sends a $25,000 QCD to his alma mater, he doesn’t need to take other money from his IRA.
A QCD won’t generate a tax deduction, but “the RMD doesn’t get included in adjusted gross income,” King says.
Thus, John will avoid adding $25,000 to his adjusted gross income.
BOTH SIDES BENEFIT
QCDs can work, regardless of whether a client itemizes deductions, according to King.
Non-itemizers will get a tax benefit of reduced AGI from a donation that they otherwise wouldn’t deduct. Itemizers will forgo the charitable deduction but may benefit from a lower AGI; QCDs might reduce the bite of the itemized deduction phase-out for high-income clients, just to name one AGI-based tax code rule.
“The only catch is that QCDs can’t be directed to a donor-advised fund, only to specific charities,” King says.
Many clients use donor-advised funds for their philanthropy.
Tim Hughes, a CFP and the director and principal in the Rockville, Md., office of wealth management firm Bronfman E.L. Rothschild, cautions that private foundations, charitable gift annuities and charitable remainder trusts also aren’t eligible QCD recipients.
“In addition, gift splitting is not allowed,” he says. “A married couple cannot donate $200,000 from one spouse’s IRA and divide the gift.”
Until recently, “the only problem with QCDs was having to wait until the end of the year to be sure Congress would renew the provision,” King says.
For nearly a decade, the QCD tax break periodically expired and then enjoyed a temporary renewal.
Now that the tax-free distribution is back on the books, here's how advisers can take full advantage.July 25
“The QCD was permanently extended when Congress approved the Protecting Americans from Tax Hikes (PATH) Act of 2015,” Hughes says.
Now that the QCD is permanent, he has another predictable planning opportunity for year-round use.
“Our preferred method is to complete the gifts of highly appreciated assets in advance of year end, transferring the appreciated position to charity soon after it increases in value,” Hughes says. “With permanence, we can apply the same approach to using the QCD.”
QCD benefits extend to estate planning and portfolio rebalancing, Hughes says.
“Now that they’re permanent, we can plan ahead,” he says. “I even have a 59-year-old client whose charitable plans include making substantial QCDs, once she reaches 70 1/2.”
This story is part of a 30-30 series on tools and strategies for retirement.