Fighting Back RMDs with Qualified Charitable Distributions (QCDs)

A key issue facing many retirees is having to take required minimum distributions (RMDs) starting at age 72, regardless of whether they need the income. RMDs must be taken from most qualified defined contribution plans such as a 401(k), 403(b), and 457. RMDs do not apply to Roth IRA plans. For retirees trying to defer taxes on their retirement funds as long as possible, this creates an unwanted tax liability.

Fortunately, retirees have an option that can offset any RMD tax liability while fulfilling their philanthropic desires. Instead of simply taking the RMD as income, they can donate it. It’s a little more complicated than that, involving what’s called a Qualified Charitable Distribution (QCD), but the ultimate benefit to you is a smaller tax bill and an appreciative charity.

How a QCD Works

Essentially, a QCD is a direct, tax-free transfer of funds from your IRA to a qualified charitable organization. To be eligible, you need to be at least 70½ and ready to take your first RMD. It’s a direct transfer, so the check must be made payable to the charitable organization. You are allowed to transfer up to $100,000 tax-free from your IRA each year even if it exceeds your RMD. If you are married, you and your spouse can each take a QCD of $100,000 each year. The money must be received by the charity by December 31st to qualify. The QCD rules also apply to IRA beneficiaries who turn 70½.

When you take a QCD, the amount transferred satisfies your RMD. For example, if your RMD for the year is $7,000, you can instead take a QCD for $7,000, which will satisfy your RMD. If the QCD was only $5,000, you would still need to take an RMD of $2,000. It is important to note that if you take an RMD earlier in the year, you can’t reverse it if you later decide to make a QCD. You can still use a QCD to transfer funds tax-free to a charity and even deduct it if you itemize, but it won’t satisfy your RMD because you already took it.

Lower Your Taxes with a QCD

When you take an RMD, the amount is added to your adjusted gross income (AGI), which determines your tax rate. If it boosts your income to more than $85,000 as a single filer or $170,000 as a joint filer, it can trigger the Medicare high-income surcharge, which increases your Part B and D premiums if your income. If your income is high enough (>$250,000), it will trigger the dastardly 3.8 percent Medicare tax.

For many taxpayers, who no longer itemize deductions under the new tax law, the QCD is a significant advantage. If you take a QCD, it is not added to your AGI, so it won’t trigger any additional tax. It can also reduce the taxability of your Social Security benefits. Keep in mind, when you use a QCD to donate to a charity, you don’t deduct it as a charitable expense (you don’t need to because you have already removed the RMD from your AGI).

What You Need to Know about QCDs

There are a few caveats. First, the QCD is not available for 401(k) plans, SEPs or SIMPLE IRAs. However, if you roll any of those plans into an IRA, it becomes QCD eligible. Second, although owners of a Roth IRA can make a QCD, it is really a moot point. There are no RMDs for Roth IRAs, and withdrawals are already tax-free. Third (this bears repeating), if you take an RMD, you cannot later make QCD. Once a check or a transfer is made in your own name, it cannot be changed.

The QCD is an excellent planning opportunity for people who struggle with having to take RMDs they don’t need and losing a portion of them to taxes. And, for the charitably inclined, it is a win-win.