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IRA Holders Can Reap Extra Tax Benefits With This Charitable Strategy

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What You Need to Know

  • QCDs can be a tax-efficient way for eligible clients to make charitable contributions.
  • QCDs can help reduce future RMDs.
  • These distributions can help retirees manage their AGI levels each year.

Qualified charitable distributions (QCDs) allow those who are 70 ½ or older to divert some or all of their distributions from a traditional IRA to a qualified charitable organization. As we approach the end of the year, many of your clients are focusing on making gifts to charities. A QCD can make sense for many of those clients who are eligible to use this technique.

What is a Qualified Charitable Distribution and How Does It Work?

QCDs were enacted as a temporary provision in 2006 and made permanent in 2015. A QCD allows those who are at least age 70 ½ to take up to $100,000 of their distributions from a traditional IRA each year and divert those withdrawals to a qualified charitable organization. The amount of the QCD is not subject to income taxes, though there is no charitable deduction available for them.

The amount of the QCD can exceed a taxpayer’s RMD amount for the year. The age to be able to commence QCDs was left at 70 ½ even after the beginning RMD age was increased to 72 under the Setting Every Community Up for Retirement Enhancement (Secure) Act beginning in 2020.

When Does a QCD Need to Be Completed for 2021?

In order to benefit from a QCD in 2021, the withdrawal from your client’s traditional IRA needs to be completed no later than Dec. 31, 2021.

Here are four reasons for your clients to consider a QCD as part of their charitable giving and RMD strategies in 2021 and subsequent years.

1. QCDs are a tax-efficient way to make charitable contributions.

For clients who are charitably inclined and who don’t need some or all of the money from their RMDs, a QCD is a tax-efficient way to make charitable contributions. While there are no charitable deductions available for the QCD, the amount distributed as a QCD is not subject to taxes.

For clients who are not in a position to make charitable contributions with cash or appreciated securities in a taxable account at a level that will provide them with the ability to itemize charitable deductions, a QCD is their best alternative to make a charitable contribution in a tax-efficient fashion.

For many clients, not having this amount reflected as a part of their taxable income for the year can be a huge planning opportunity.

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2. QCDs can reduce future RMDs.

QCDs can serve to reduce the level of future RMDs for your client. Any money that comes out of a traditional IRA does this. In the case of a QCD, the fact that they can start as early as age 70 ½ can help clients manage their future RMDs while making charitable contributions that are not taxed as they come out of the account. Using QCDs prior to age 72 can help reduce the amount subject to RMDs once your clients reach that age.

There are other strategies to reduce future RMDs. A Roth IRA conversion is a popular strategy, but Roth conversions do come with a potentially large tax bill in the year of the conversion. Combining the use of QCDs with strategies such as Roth conversions can make a real dent in the level of future RMDs for clients.

3. They can help manage AGI.

For many clients, not having this amount of the QCD reflected as a part of their taxable income can have significant planning benefits in terms of managing their adjusted gross income levels. For example, the cost of your client’s Medicare Part B premiums are determined by their modified AGI. The amount of the QCD will reduce taxable income and can help your client manage their AGI to help them keep their Medicare premiums lower in future years.

Depending upon your client’s situation, they could face phase-outs based on the level of their AGI for things such as the eligibility to make Roth IRA contributions if they have earned income, utilizing certain itemized deductions and exemptions and managing the net investment income tax connected with the taxation of long-term capital gains.

4. QCDs are made as an individual.

In the case of a married couple, each spouse has their own $100,000 annual limit for QCDs from their respective traditional IRAs, just as they each have their own RMD. For married clients, having both clients take a QCD from their traditional IRAs can allow them to make significant charitable contributions in some cases. Depending upon their situation and desires, they could give up to $100,000 each to qualified charities.  

A Caution About QCDs

One cautionary note about QCDs for clients making contributions to a traditional IRA after age 70 ½which is allowed under the Secure Act: These contributions can affect the amount of QCDs allowed for that client

QCDs are a viable planning tool for clients who are at least age 70 ½ and charitably inclined. Your guidance can help your clients determine if QCDs are right for them in 2021 and beyond. 

Image: Chris Nicholls/ALM, Adobe Stock