More than ⅓ of American households have an individual retirement account (IRA). Yet, few know that when you make withdrawals from your IRA, you have to pay income tax on the funds you withdraw. You can bypass income tax on your required withdrawal by donating directly to a qualifying charity. IRA holders are required to take required minimum distributions (RMDs) each year once they turn 72. This applies even if you don’t need or want the funds, and also increases your total taxable income, which could inevitably push you into a higher tax bracket if your RMDs are high. This is where making charitable donations from IRAs come in handy, not only for your own tax and RMD strategy, but for worthy causes that are close to your heart.
What Qualifies as a Charitable Donation From an IRA?
Formally known as a Qualified Charitable Distribution (QCD), a charitable donation from an IRA is a direct transfer of funds from your IRA custodian to a qualified charity. This charitable donation counts towards satisfying your required minimum distributions for the year and excludes the amount donated from taxable income, effectively lowering your taxable income and reducing the impact of your income on eligibility for retirement services like Medicare and Social Security.
A QCD may also reduce the required minimum distributions for future years as the IRA balance is reduced. The QCD tax break was made permanent in 2015 with the Protecting American from Tax Hikes (PATH) Act. It is important to note that a QCD cannot be carried over through the years and donors cannot receive any benefit or compensation from donating to charity, such as tickets for a charity event. If you do make a charitable donation to an IRA, be sure to carefully follow the following requirements.
What Requirements Should a Qualified Charitable Distribution Meet?
Your donation should meet the following QCD requirements:
- The IRA owner must be 70 1/2 or older to donate tax-free. While the QCD amount is not taxed, you may not then claim the distribution as a charitable tax deduction.
- Individual donors can transfer up to $100,000 per year, or $200,000 if done in a couple.
- The donation must be made by December 31 each year.
- The donation can only be made from IRAs, not other retirement accounts.
- The donation should also satisfy the required minimum distributions from your IRA. You can withdraw the rest of it as retirement income so you meet the minimum distribution requirement by the end of the calendar year. This will be taxed when you withdraw it.
You should also consider and calculate your QCD tax break. The donation doesn’t have to be a high amount to save you money in taxes because the amount it takes to make a difference depends on your tax rate. The higher the tax bracket, the bigger the benefits of making a charitable donation from your IRA.
Can I Donate to the Charity of My Choice?
You must choose a qualifying charity to give your money to. Qualifying charities include religious, scientific, literary, and educational organizations such as universities. They must be a 501(c)(3) organization, which means they are eligible to receive tax-deductible contributions. This does not include private foundations or donor-advised funds. That’s not to say you have to put all of your donations in one basket, you can distribute to multiple charities in the same year to a total of up to $100,000. The IRS has a Tax-Exempt Organization Search tool, which is a great resource for finding qualifying 501(c)(3) organizations.
How Should the Charitable Donation be Transferred?
The donation must be set up through a direct transfer to a charity to qualify for the tax break. Under normal circumstances, if you withdraw the money and later donate it, it won’t be a tax-free qualified charitable distribution. However, the 2020 Coronavirus Aid, Relief, And Economic Security (CARES) Act allows IRA owners to make donations of more than $100,000 and to withdraw contributions without paying income tax on them and later donating them free of percentage limitations. This also means that people who used QCD might instead donate next year so those funds will be tax-exempt, according to The Wall Street Journal.
Making a Qualified Charitable Donation From Your IRA
If you are considering making a charitable donation from your individual retirement account (IRA), a top fiduciary financial advisor can help you determine how both your IRA and charity of choice might benefit from a donation. They will also be able to help minimize your tax liability and maximize the value and impact of your donation, as well as understand how it might differ from state to state. Making a charitable donation might make sense for your situation if you don’t need the funds from your minimum distribution requirement, would like to reduce your IRA balance, or would like to make a larger charitable gift than you could from your gross income. Ensure your charitable donations from your IRA benefits not only your own tax and RMD strategy, but also the causes that are close to your heart.
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