Did you know that, if you are at least 70½ years old, you can make tax-free charitable donations directly from your Individual Retirement Account (IRA)? By making what's called a qualified charitable distribution (QCD), you can benefit your favorite charity while excluding up to $100,000 annually from gross income. These gifts would otherwise be taxable IRA distributions.1
How QCDs work
In order to make a QCD, you simply instruct your IRA trustee to make a distribution directly from your traditional IRA (other than SEP and SIMPLE IRAs) to a qualified charity. The distribution must be one that would otherwise be taxable to you. You can exclude up to $100,000 of QCDs from your gross income each year. And if you file a joint return, your spouse (if 70½ or older) can exclude an additional $100,000 of QCDs. Note: You don't get to deduct QCDs as a charitable contribution on your federal income tax return—that would be double-dipping.
QCDs count toward satisfying required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution. However, distributions that you actually receive from your IRA (including RMDs) and subsequently transfer to a charity cannot qualify as QCDs.
As indicated earlier, a QCD must be an otherwise taxable distribution from your IRA. If you've made nondeductible contributions, then normally each distribution carries with it a pro-rata amount of taxable and nontaxable dollars. However, a special rule applies to QCDs—the pro-rata rule is ignored, and your taxable dollars are treated as distributed first.
If you have multiple IRAs, they are aggregated when calculating the taxable and nontaxable portion of a distribution from any one IRA.
Please note: RMDs are calculated separately for each traditional IRA you own but may be taken from any of your IRAs. Also, your QCD cannot be made to a private foundation, donor-advised fund, or supporting organization [as described in IRC Section 509(a)(3)]. Further, the gift cannot be made in exchange for a charitable gift annuity or to a charitable remainder trust.
Why are QCDs important?
Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would be a bit more cumbersome and possibly more expensive. You would request a distribution from the IRA and then make the contribution to the charity yourself. You'd include the distribution in gross income and then take a corresponding income tax deduction for the charitable contribution. But due to IRS limits, the additional tax from the distribution may be more than the charitable deduction. And due to much higher standard deduction amounts ushered in by the Tax Cuts and Jobs Act passed in 2017, itemizing deductions may have become even less beneficial in 2018 and beyond, rendering QCDs even more potentially appealing.
QCDs avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity—you don't report the IRA distribution in your gross income, and you don't take a deduction for the QCD.
Can I name a charity as beneficiary of my IRA?
Yes, you can name a charity as beneficiary of your IRA, but be sure to understand the advantages and disadvantages.
Generally, a spouse, child, or other individual you designate as beneficiary of a traditional IRA must pay federal income tax on any taxable distribution received from the IRA after your death. By contrast, if you name a charity as beneficiary, the charity will not have to pay any income tax on distributions from the IRA after your death (provided that the charity qualifies as a tax-exempt charitable organization under federal law), a significant tax advantage.
After your death, distributions of your assets to a charity generally qualify for an estate tax charitable deduction. In other words, if a charity is your sole IRA beneficiary, the full value of your IRA will be deducted from your taxable estate for purposes of determining the federal estate tax (if any) that may be due. This can also be a significant advantage if you expect the value of your taxable estate to be at or above the federal estate tax exclusion amount ($12.06 million for 2022).
Of course, there are also nontax implications. If you name a charity as sole beneficiary of your IRA, your family members and other loved ones will obviously not receive any benefit from those IRA assets when you die. If you would like to leave some of your assets to your loved ones and some assets to charity, consider leaving your taxable retirement funds to charity and other assets to your loved ones. This may offer the most tax-efficient solution, because the charity will not have to pay any tax on the retirement funds.
If retirement funds are a major portion of your assets, another option to consider is a charitable remainder trust (CRT). A CRT can be structured to receive the funds free of income tax at your death and then pay a (taxable) lifetime income to individuals of your choice.
When those individuals die, the remaining trust assets pass to the charity. Finally, another option is to name the charity and one or more individuals as beneficiaries. You may allocate the percentage among beneficiaries (individuals and charities) as you see fit. Note: There are fees and expenses associated with the creation of trusts.
The legal and tax issues discussed here can be complex. Be sure to consult an estate planning attorney or your financial advisor for further guidance.
To learn more about the comprehensive services offered by Busey Wealth Management, visit busey.com/wealth-management.
1 Beginning after 2019, if you make deductible contributions to an IRA for the year you reach age 70½ or beyond, this could reduce the allowable amount of your QCD.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
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