Many of our clients have enjoyed successful careers, saved wisely, and accumulated enough assets to retire comfortably. Now these clients are near retirement, or have already retired, and are working with us to plan for how to live off these assets. In many cases, the “vehicle” clients have used to save money is a 401(k) retirement plan account, which they usually “roll” into Individual Retirement Accounts (IRAs) after retirement. Since these accounts were typically accumulated via pre-tax contributions and will not be taxed until withdrawn from the account, naturally the IRS wants taxpayers to eventually pull this money out and pay the tax. Enter the Required Minimum Distribution (RMD).
RMDs are a requirement by the IRS for anyone who has reached the age of 70 ½ to start distributing assets out of their 401(k) and IRA accounts. The required distribution amount is calculated by dividing the value of your retirement account by a factor provided by the IRS: the larger the account, the larger the RMD. As you get older, you are required to withdraw a larger percentage of the account, resulting in more taxable income.
Often, our clients have accumulated significant assets in other after-tax accounts in addition to having large pre-tax retirement accounts. They then discover the distribution required by the IRS through the RMD is more than they need to cover their living expenses. In other words, they have other assets they can draw from more tax-efficiently to pay their expenses. For clients who find themselves in this position who are also charitably inclined, one of the best tax strategies is a Qualified Charitable Distribution (QCD).
With a QCD, an individual who is 70 ½ or older can distribute funds directly from their IRA to a qualified charity and use this distribution to satisfy their RMD. Further, the QCD is not considered a taxable distribution to the account owner. While the QCD is not deductible as a charitable contribution for those who itemize their deductions, the substantial increase in the standard deduction under the new Tax Cuts and Jobs Act has made itemizing deductions unnecessary for many taxpayers. The QCD allows taxpayers who no longer receive the benefit of deducting their charitable contributions to continue to make these contributions with pre-tax funds. Since the QCD is not included in taxable income, there could be many indirect tax benefits as a result of lower taxable income, such as lower phaseout thresholds and lower Medicare premiums.
The dollar limit for the QCD is $100,000 per IRA owner per calendar year and represents the aggregate of QCDs made to one or more qualifying charities. This distribution must be made directly from the IRA custodian to a qualified public charity which excludes donor-advised funds and most private foundations. It is preferable to make QCDs out of Traditional IRA and Inherited IRA accounts since distributions from Roth IRAs are already tax-free. QCDs are not eligible from company retirement plans such as 401(k)s, 403(b)s, SEP-IRAs, and Simple IRAs. Therefore, if the taxpayer has separated service from the company providing one of these plans and would like to make a QCD, they would first need to roll the funds into a Traditional IRA. As a final note, QCDs are a relatively new type of retirement plan distribution to be processed by the IRS so it’s important to work with a qualified professional to appropriately document the transaction.
As the end of the year approaches, many people are planning year-end giving and many retirees are facing new or rising RMDs. It may be a good time to discuss whether a QCD is the right move for you.
Michael P. Denny, CPA, CFP®
Michael P. Denny is a member with GranthamPoole PLLC and a recognized leader in the fields of financial and tax planning, investment consulting, and estate planning. Michael regularly consults with high net-worth and high-income individuals, business owners, estates and trusts. He is the leader of the Financial Planning Advisory Service team at GranthamPoole. Please contact Michael at firstname.lastname@example.org or 601-499-2400. CPA License # 5641
Contributing Author: Leyna Ford is a corporate and individual taxation accountant at GranthamPoole PLLC with a keen interest in financial and estate planning.
***The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.