If philanthropy and charitable intent are important to you, devising a strategy for giving may maximize your donations. It may also be efficient for your taxes across your whole financial portfolio.
A qualified charitable distribution (QCD) is a distribution from an IRA account that you are entitled to from the age of 70 ½. However, these contributions go directly to your designated non-profit organization and are not included in your federal taxable income. By reducing your income, you may avoid taxing your Social Security benefits and subjecting yourself to Medicare premium surcharges known as IRMAA. Additionally, the IRS lets these QCDs count as a required minimum distribution (RMD) from an IRA.
What follows are some guidelines to consider and limits to be aware of when it comes to including QCDs in financial planning to help you reach several future goals.
Lowering Your Required Minimum Distributions (RMDs)
From age 72, the IRS’s rule regarding RMDs from retirement accounts commences with regard to any tax-deferred savings accounts. RMDs are calculated using a formula that combines the monetary value of the account at the end of the previous year and the retiree’s age.
RMDs can be quite large but are ultimately determined by the account’s value. This can be problematic for taxpayers who want to keep their income below certain thresholds, as by staying in a lower tax bracket, they avoid additional taxes and surcharges on benefits like Social Security and Medicare.
- The QCD may meet your RMD for a year as long as the QCD is entered by the deadline for the RMD (typically December 31st each year)
- A QCD can only be distributed with pre-tax amounts. QCD rules state that you cannot designate pre-tax funds in place of pro-rating a distribution between pre-and-post-tax amounts. This helps lower the taxable funds in an IRA for any distributions in subsequent years.
Do You Itemize or Take the Standard Deduction? QCDs Have Great Perks!
Qualified charitable distributions don’t need to be submitted with a list of itemized deductions – you may claim the standard deduction. However, you will need to provide a list of itemized deductions if you take a normal distribution and then claim a charitable gift in your tax returns to offset the distribution.
The rules on QCDs are useful when making a more significant financial contribution. Charitable gift tax deductions are limited to a percentage of a person’s adjusted gross income (AGI). QCDs are not, however, limited this way. QCD is limited to $100,000 annually per individual.
Avoiding (or Minimizing) Taxes on your Benefits like Social Security and the Medicare IRMAA
Social Security is taxable, up to 85%. The tax paid is dependent upon a taxpayer’s modified adjusted gross income (MAGI). This is simply the AGI with other interest income combined. Keeping your AGI on the lower end will help minimize your taxable income – and the amount of Social Security that is taxed.
The impact of the Medicare surcharge hits only certain higher income levels. The owed amounts are pre-set, so missing a cut-off by just a few dollars may mean you’ll enter into a higher bracket with significantly higher premiums to pay. By filing joint taxes, premiums will increase for both parties, unfortunately. However, by keeping your income low with the QCD to meet an RMD, you can go a long way to help manage your annual federal tax obligation.
What deems Charities as “Qualified”?
Charities that may receive tax-deductible contributions under rule 501(c) (3) are deemed qualified. Private foundations and donor-advised funds do not qualify for any QCDs.
Charitable donations are an excellent way to be philanthropic and give back. By gifting within the parameters of your financial plan, you may find the ongoing benefits highly fulfilling. Furthermore, carefully structuring and minimizing taxes you owe can enhance the amount you can give over your financial plan.
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