As the end of year approaches, it’s a good time to address important financial matters. In this blog post, we will specifically discuss Required Minimum Distributions (RMDs) and how to advantageously incorporate them into charitable gifting strategies.
What Are RMDs?
Once you turn 73, the IRS generally requires you to start withdrawing from certain retirement accounts such as your traditional IRA, 401(k), or similar employer-sponsored retirement plans. These withdrawals are known as Required Minimum Distributions (RMDs).
Your RMD for any year is the account balance, as of the end of the prior calendar year, divided by a life-expectancy factor according to the IRS.
If you fail to take your RMD, the IRS imposes a significant penalty — 25% of the required amount. The deadline for your first RMD is typically April 1 of the year following your 73rd birthday, with subsequent RMDs due by Dec. 31 each year after that.
But what if you don’t need your RMD income for your daily expenses? You’re still required to take it, and it will be taxed as income in the year of the distribution, potentially leading to unintended tax consequences.
Gifting Your Required Minimum Distribution
If you’re interested in supporting a charity and potentially lowering your tax bill, consider a Qualified Charitable Distribution (QCD). Beginning at age 70, you can direct your RMD straight from your IRA to a chosen charity through a QCD.
Why Consider a Qualified Charitable Distribution?
In addition to supporting a charitable cause, a QCD may offer several benefits:
- Reduced tax liability — each year, the amount of your RMD is added to your adjusted gross income (AGI), which may translate into a higher tax bill. A QCD, on the other hand, won’t increase your AGI because the money is transferred directly to the charity.
- Reduced taxes on your Social Security benefit — your Social Security benefits are taxed based on your income level. As mentioned above, a QCD can lower your AGI, potentially reducing the amount of tax on your Social Security benefits.
- Reduced Medicare premiums — Medicare premiums are also income based. A lower AGI can potentially reduce these premiums. Not everyone faces Medicare premiums, so be sure to consult with a tax professional about how this could affect you.
What Else Should You Know About QCDs?
There are other considerations with this strategy:
- If you make deductible contributions to your IRA during or after the year in which you reach age 70½, these will reduce the tax-deductibility of future QCDs.
- Employer-sponsored retirement accounts, such as a 401(k), do not qualify for a QCD. But you can roll your RMD funds from a 401(k) into an IRA, which would make them eligible for the strategy.
- Since Roth IRA withdrawals are generally tax-free, gifting from a Roth IRA is less beneficial.
Not everyone qualifies to use the QCD strategy, so you’ll want to speak with your tax professional and financial advisor before proceeding. If you’re eligible to use a QCD, your financial team can work with your tax professional to help accomplish your charitable goals in a tax-efficient manner.
Gifting Through a Donor-Advised Fund
If you’re seeking a more permanent gifting solution, a donor-advised fund (DAF) might meet your needs. As a donor, you make an irrevocable contribution to the fund and receive an immediate tax deduction. Although DAFs can be a flexible way to maximize charitable giving, sponsoring organizations may require higher contributions upfront. Also, unfortunately, QCDs cannot be used to fund a DAF.
Taking the time to review your financial strategy as the year draws to a close can help ensure you’re making the most of your charitable giving. Whether through RMDs, QCDs, or DAFs, thoughtful planning can lead to significant tax savings while supporting the causes that matter most to you.
Consult with your financial and tax professionals to explore the options that best align with your goals.