As the year draws to a close, it’s a great time to do some financial planning. 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 we reach our 70s, the IRS generally requires us to start withdrawing from certain retirement accounts such as traditional IRAs, 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 calculated by the IRS.
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. If you fail to take your RMD, the IRS imposes a significant penalty — 25% of the required amount.
But what if you don’t need your RMD income for your daily living expenses? You’re still required to take it, and it will be taxed as income in the year of the distribution, potentially leading to 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 distributions from your IRA to a charity of your choice through a QCD.
Why Consider a Qualified Charitable Distribution?
In addition to supporting a charitable cause, a QCD may offer several benefits:
- Reduction in AGI — Distributions from qualified retirement accounts are added to your adjusted gross income (AGI), which may translate into a higher tax bill. QCDs won’t increase your AGI because the money is transferred directly to the charity.
- Reduced taxes on Social Security — Social Security benefits are taxed based on AGI. 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?
- 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 will lose the tax benefits of a QCD from a traditional IRA.
A QCD strategy doesn’t make sense for everyone, so you’ll want to speak with your tax professional and financial planner about whether it might benefit you before proceeding.
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, irrevocable contributions are made to the fund and you’ll 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.