When we as financial planners talk with clients about “efficiency” in giving, we are generally referring to tax efficiencies. We operate on the assumption that most people have a desire to contribute to charities, and believe it is important to help clients facilitate this desire in a way that provides the most tax benefit to the giver, so that in turn, they have more to give to their favorite charities.
Fortunately, there are a number of ways to enhance this efficiency, and we will spend a little time over the next few weeks covering them in more detail, beginning with one of the best techniques that is also one of the least utilized: the Qualified Charitable Distribution.
What is a Qualified Charitable Distribution (QCD)?
A Qualified Charitable Distribution is connected to your IRA (Individual Retirement Account) and only works for individuals who have an IRA and are at least 70 ½ years of age. What? Why?
Because at 70 ½ years of age, individuals must begin their Required Minimum Distributions from ALL tax-sheltered types of accounts, and pay taxes on those distributions at your individual tax rate. (Note: This requirement does NOT apply to Roth IRA’s). Failure to take your Required Minimum Distribution will result in a 50% tax penalty of the amount you were supposed to take and did not! Wow…OK, I guess I will take out what I must.
The Qualified Charitable Distribution is simply allocating some or all of your Required Minimum Distribution to a charity, rather than having it made payable to you.
What are the tax benefits?
The IRS regulation for Qualified Charitable Distributions was finally made permanent in 2015, and up until that point, it was allowed in some years, and not in others, which made tax planning pretty difficult. Now however, once you know how much you have to take each year- an amount that is determined at the start of each calendar year- you can decide how much of that you want to be made payable to a charity instead. Whereas any distributions from an IRA that are payable to you are taxed, distributions from an IRA that are directed to a charity are not taxed…at all.
Because you have decided to essentially give some or all of your Required Minimum Distributions to charity, and will not have to add these required distributions to your regular income, you will actually realize a much greater benefit tax-wise, than if you had the money first paid to you and then given to your favorite charities. Remember, if any money is distributed as payable to you from an IRA, you WILL pay taxes on it. And because of the 2018 tax law changes, it has become even more difficult for individuals to give enough to charity for it to even impact the bottom line of their taxes.
How do I set up a Qualified Charitable Distribution?
If you have decided that you are eligible (age 70 ½) and want to gift your Required Minimum Distribution, there are some very specific and important steps to follow to make the Charitable Distribution work for you:
- Determine the charities that you want to give to: all of them should be classified as 501(c)(3), the IRS code for non-profits. Not every charitable group possesses this designation, but you can contact them to ask.
- Contact your IRA custodian (bank or brokerage firm such as Schwab or Fidelity, etc.) or your financial advisor and inform them that you want to request a Qualified Charitable Distribution- there may be some forms or other info that you need to complete.
- Decide how much you want to go to each charity, and provide those names to the custodian. There will also need to be enough cash available in your account to make the requested distribution.
- Make sure that your Qualified Charitable Distribution request is not designated to have taxes withheld on the distribution; you won’t owe any taxes on it, and you want ALL the money to go to the charity.
- The custodian will typically generate a check made out to the charity of your choice, send the check to you, and you will then have to forward it to the charity. In some cases, the custodian will send the check directly to the charity, but for tracking purposes (see below), it might be better for the check to come to you first.
Additional Notes & Details:
- The maximum Qualified Charitable Distribution that can be made per individual IRA owner is $100,000 per year. If you are married and both have IRA’s, you could each contribute that max of $100,000 per year from each of your IRA’s.
- The QCD should be used for those that would receive larger gift amounts, say over $100; your smaller contributions should come out of pocket.
- You may also set up QCD’s to be paid out monthly, if your custodian allows it, as many individuals prefer to do with gifting to their churches, etc. For convenience, we usually recommend annual gifts, but that is a personal choice.
- Try to complete all your gifts and distributions by early December. Ideally, you want the checks to charities to clear before year-end.
- You will need to keep track of the checks that you receive and then forward to charities, and would be wise to make copies. You will also need to keep the acknowledgements you receive from the charities for your gift.
- This record keeping becomes very important at tax time, because ALL distributions, whether they are made to you or a charity are reported on a regular 1099 from the custodian, and they do not break out those distributions that were made out to charities. You will need to provide your tax preparer with that documentation, so that it can be correctly entered on your tax return. This is how you realize those tax savings.
It can be a little more work to set up Qualified Charitable Distributions, but you will need to make decisions about your Required Minimum Distributions every year anyway. Taking the time to include charities in your distribution plan will not only be rewarding to you by not having to pay taxes on those amounts, but of course it enables you to support the missions and causes that matter to you. And if you are someone who does not need the funds that you are required to take, what a great opportunity this is to have a positive impact on others.