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IRA Charitable Distribution
As a nonprofit organization that focuses on providing seniors with affordable in home care services, we recognize the significance of preparing for the future and optimizing financial resources.
What is a Qualified Charitable Distribution?
A qualified charitable distribution (QCD) allows individuals who are 70½ years old or older to donate up to $100,000 total to one or more charities directly from a taxable IRA instead of taking their required minimum distributions.
As a result, donors may avoid being pushed into higher income tax brackets and prevent phaseouts of other tax deductions, though there are some other limitations.
How do qualified charitable distributions work?
Understanding qualified charitable distributions begins with understanding required minimum distributions. People who hold Individual Retirement Accounts (IRAs) are required to take RMDs each year beginning at age 73—even if they don’t need or want the funds. That same required minimum distribution increases the IRA holder’s total taxable income.
This income increase could potentially push the taxpayer into a higher income tax bracket. It can also trigger phaseouts, which limit or eliminate some kinds of tax deductions, such as personal exemption and itemized deductions, and sometimes trigger high taxes on Social Security income.
How QCDs Work: QCDs are also called IRA charitable distributions or IRA charitable rollovers. They enable individuals to fulfill their required minimum distribution by a direct transfer of up to $100,000 to charity.
They can also be used support multiple charities, as long as the sum of the distributions is within the $100,000 limit. But because QCDs don’t increase taxable income, both higher tax rates and phaseouts can be avoided.
In addition, because QCDs reduce the balance of the IRA, they may reduce required minimum distributions in future years. QCDs are also not counted toward the maximum amounts deductible for those who itemize their giving on their taxes—the $100,000 can be above and beyond those limits.
For these reasons, a QCD can potentially enable a donor to give a bigger charitable gift than they could if they just donated cash or other assets. Learn more about charitable tax strategies.
How QCDs are made: Qualified charitable distributions are made directly to the eligible charity from a traditional IRA, inherited IRA, inactive Simplified Employee Pension (SEP) plan and inactive Savings Incentive Match Plan for Employees (SIMPLE) IRAs. (Inactive SEP and SIMPLE IRAs are accounts that no longer receive employer contributions.)
The money is a direct transfer that never passes through the hands of the IRA holder. Instead, the IRA custodian can either send a check directly to the charity or the account owner, who then hands it over to the charity.
For a QCD to count toward your minimum annual IRA distribution, it must be made by the same deadline as a normal distribution, which is usually Dec. 31 of the tax year in question.
Who can make a qualified charitable distribution?
An individual donor can contribute up to $100,000 per year in QCDs, as long as that individual is 70½ years old or older. For married couples, each spouse can make QCDs up to the $100,000 limit for a potential total of $200,000.
The $100,000 per person limit applies to the sum of all QCDs taken from all IRAs in a year. A donor can make one large contribution or several smaller contributions over the course of the calendar year. Remember that QCDs can be made from any or more than one of the IRA types (traditional, inherited, inactive SEP and inactive SIMPLE IRAs) noted above.
Type of charity that can receive a QCD
Qualified charitable distributions can be made only to certain qualified charitable organizations, as defined in the tax code.
Currently, QCDs cannot be made to donor-advised fund sponsors, private foundations and supporting organizations, though these are categorized as charities. NOTE: Donors should check before making a gift to ensure the organization is qualified to accept QCDs.
Tax limitations of QCDs: A donor can make a qualified charitable distribution that exceeds the individual’s required minimum distribution for a given year; however, that extra distribution can’t be carried over—i.e., used to meet the minimum distributions for future years.
This contrasts with other strategies, such as a donation of cash and appreciated securities, where a large donation can be made in one year and the tax benefits can be carried forward. It also differs from contributions to a donor-advised fund or foundation, which can also allow you to front-load giving in a high-income year and use those funds support charities in the future.
Additionally, donors cannot receive any benefit for making a qualified distribution to a charity. So, for example, a QCD cannot be used to purchase something in a charity auction or purchase tickets for a charity golf tournament.
State tax rules on QCDs vary, so donors using charitable distributions should consult a tax advisor to understand the impact on state tax liabilities.
Recipient limitations of QCDs: One additional and relevant limitation of QCDs is that they can’t be used to support every type of charity; certain charities do not accept them, as noted above.
Does a QCD make sense for me?
A QCD can provide several potential benefits. It may be a suitable giving strategy for donors who:
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Are required to take a minimum distribution from an IRA, but don’t need the funds and would face increased tax liabilities if they took the distribution as income.
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Would like to reduce the balance in an IRA to lower future required minimum distributions.
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Would like to make a larger charitable gift than they could if they simply donated cash or other assets. The value of charitable gifts that can be deducted from a tax return usually ranges from 20 to 60 percent of the donor’s adjusted gross income. This AGI-based limit does not apply to QCDs, allowing donors to make larger gifts.
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Do not wish to make their contribution to a foundation or donor-advised fund.
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Have identified which charities they want to support immediately with a substantial gift.
When might a qualified distribution not be effective?
Although qualified charitable distributions can be a good option in the right circumstances, they may not be the best charitable giving strategy for everyone. For example, if you have securities that have grown in value since you bought them, it may make more sense and provide greater tax benefit to donate them to charity instead of taking a QCD.
Additionally, if you prefer to take a tax deduction in the current year and then support charities over time, as you can when you contribute to a donor-advised fund, a QCD may not be the right option.
If you are considering a large charitable donation, a CPA or financial advisor can help you minimize your tax liability and maximize the value and impact of your gift by choosing the right strategy or combination of strategies for your situation.
Donating an IRA and other retirement assets
Donating an IRA or other retirement assets to charity can be a tax-smart estate planning strategy.
It is always possible to donate retirement assets, including IRAs, 401(k)s and 403(b)s, by cashing them out, paying the income tax attributable to the distribution and then contributing the proceeds to charity.
In many cases, though, there is little to no tax benefit associated with this type of donation.
However, a direct contribution of retirement assets to charity as part of an estate planning strategy can be very tax efficient. In some situations, it can mean more funds for charities and heirs alike.
For many people, a retirement account like an IRA or 401(k) may be the most significant source of assets accumulated in their lifetime.
Others may find that, due to their other resources and investments, they are not in need of all the funds accumulated in their retirement accounts. For those who wish to give to charity, a natural question is whether they can donate retirement assets—and if there are any tax advantages for doing so.
Options for donating retirement assets
Donating during your lifetime: In order to donate retirement plan assets during your lifetime you would need to take a distribution from the retirement account, include the distribution in your income for that year, account for any taxes associated with the distribution, and then contribute cash to the charity—with one exception.
People who are age 70 ½ or older can contribute up to $100,000 from their IRA directly to a charity and avoid paying income taxes on the distribution. This is known as a qualified charitable distribution. It is limited to IRAs, and there are other exclusions and considerations as well.
As part of an estate plan: By contrast, there can be significant tax advantages to donating retirement assets to charity as part of an estate plan.
When done properly, charitable donations of retirement assets can minimize the amount of income taxes imposed on both your individual heirs and your estate.
Tax implications of donating retirement assets during life
Retirement plan benefits are only payable to the employee or account holder who earned them, with a few exceptions for spouses or survivors.
With the exception of a qualified charitable distribution as described above, distributions from non-Roth retirement plans are taxable as ordinary income to the person who receives them.
This is true whether the recipient is the original account holder or a beneficiary of the account holder. Unlike other inheritances that can be passed to heirs free of income tax, distributions from inherited retirement plans are taxable as ordinary income to the person who receives them.
TIP: If you want to support charities without dipping into your cash reserves, think about donating appreciated assets such as stocks or privately held business interests directly. This strategy can eliminate capital gains taxes you’d incur by selling them separately before donating the cash, therefore ensuring that your intended charity receives the full value of the asset.
Donating an IRA to charity upon death
When you name a charity as a beneficiary to receive your IRA or other retirement assets upon your death, rather than donating retirement assets during your lifetime, the benefits multiply:
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Neither you and your heirs nor your estate will pay income taxes on the distribution of the assets.
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Your estate will need to include the value of the assets as part of the gross estate but will receive a tax deduction for the charitable contribution, which can be used to offset the estate taxes.
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Because charities do not pay income tax, the full amount of your retirement account will directly benefit the charity of your choice.
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It’s possible to divide your retirement assets between charities and heirs according to any percentages you choose.
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You have the opportunity to support a cause you care about as part of your legacy.
How to designate a charity as the beneficiary of an IRA or 401(k)
When you’re ready, making a charity the beneficiary of your IRA or other retirement assets is typically straightforward:
Fill out a designated beneficiary form through your employer or your plan administrator.
Most banks and financial services firms also have beneficiary forms, or they can provide you with suggested language for naming beneficiaries to these accounts.
Once the designated beneficiary forms are in place, the retirement assets will generally pass directly to your beneficiaries (including charities) without going through probate.
If you are married, ask the plan administrator whether your spouse is required to consent. If required but not done, this could result in a disqualification of the charity as your beneficiary.
Be clear about your wishes with your spouse, lawyer and any financial advisors, giving a copy of the completed beneficiary forms as necessary.
TIP: If your goal is to support charity as part of your legacy while also leaving assets to family members, it may be more tax efficient to leave cash and appreciated assets to heirs, while making charities the beneficiaries of retirement assets upon your death.
Advantages of making a donor-advised fund a retirement account beneficiary
Although designating any qualified charity as a beneficiary usually allows an estate to claim a charitable contribution deduction, naming a public charity with a donor-advised fund program—such as Fidelity Charitable—as beneficiary of a tax-deferred retirement account such as an IRA or 401(k) gives clients and heirs more flexibility.
A donor-advised fund is a program of a public charity that functions like a tax-advantaged charitable checking account that can be used solely for giving.
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Upon death, your IRA assets can fund the donor-advised fund. It can then be distributed to charities immediately or over time through an endowed giving program. Or you can let a trusted friend or family member make the choice—a designated account successor can then make grant recommendations over time to the charities they would like to support.
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Alternatively, you can use your assets to provide multiple heirs with a fund to support their individual charitable giving by specifying that the IRA be allocated across multiple Giving Accounts. In that case, each individual will have their own Giving Account, creating a legacy of giving that can stretch far into the future.
*Traditional IRAs, 401(k)s and 403(b)s may contain after-tax contributions that are not subject to income taxes. If they do, there are special tax rules to determine what portion of a withdrawal is attributable to after-tax contributions. This article does not address those rules. Withdrawals from Roth IRAs, Roth 401(k)s and Roth 403(b)s, along with their associated earnings, are generally free from income taxes if certain conditions are met.