Should You Consider Qualified Charitable Distributions?

Christine Benz:

Hi, I'm Christine Benz from Morningstar. Retirees love to hate their required minimum distributions, but the qualified charitable distribution is one way to find a silver lining. Joining me to discuss what a QCD is and how retirees can take advantage of it is tax and retirement planning expert, Ed Slott.

Ed, thank you so much for being here.

Ed Slott:

Great to be here. Thanks, Christine.

Benz:

Ed, let's talk about charitable giving in 2022. There were some provisions put into the tax code in the wake of the pandemic, but some of them are going away in 2022. So, what do people need to know about that?

Slott:

Well, in general, for a few years now, most people still don't realize they're not getting really any tax benefit out of the money that they give to charity. So, as you said, there were special provisions that ended in 2021 where you could, even if you didn't itemize--and that's the reason most people weren't getting the tax benefit out of their charitable donations is because most people don't itemize anymore because the standard deduction for most people is much higher--but in the pandemic Congress put in some breaks where you could actually deduct, even if you weren't itemizing, $300 or $600 a joint return. It doesn't matter anymore because you can't do it anymore. That ended in '21. And also, for people that gave so much that they could itemize, they were able to give up to 100% of their adjusted gross income. So, that could help people with big deductions. That's gone, too. It goes right back down to 60% where it was before. So, those provisions are gone. Not on the returns that you're filing now for 2021. If you already did that in '21, you're OK. But for your charitable giving now in 2022, they're gone.

Benz:

I want to focus on one charitable giving strategy that is still available in 2022. This is the qualified charitable distribution. Can you talk about that and why it's so advantageous from a tax standpoint?

Slott:

Well, again, most people are not getting any tax benefit in terms of a deduction for the gifts they give to charity because they take the standard deduction. But thanks to this provision--it's one of my favorite provisions of the tax code; the only negative part about it, it's not available to enough people--so, if you are giving to charity, and I always want to make this clear: I'm never saying give all your money to charity to lower your taxes; you'd be broke. I'm saying if you're already giving to charity, change the way you're doing it if you qualify for qualified charitable distributions, which is a direct transfer from your IRA to the charity.

What's the benefit? Well, obviously, there's no itemized deduction because you're probably taking the standard deduction. But in this case, you get better than an itemized deduction. You get an exclusion from income. You're actually pulling money out of your IRA, not really because it goes right to the charity, at zero tax cost. But this is a gift you were going to make anyway, so it reduces your adjusted gross income, and that's a key number on a tax return that determines whether you qualify or get hit with other benefits, credits, deductions, and things like that. So, you take a direct transfer from your IRA to a charity. But the downside is it only applies to IRA owners, not people in company plans like 401(k)s. Only IRA owners and IRA beneficiaries who are 70.5 years old or older. Now, I know people might be saying, "Well, don't you know that the Secure Act raised the required minimum distribution, RMD, age to 72?"--but it did not affect the 70.5 age for QCDs. So, you can do that transfer up to $100,000 per year, so that's a big amount, a direct transfer, and it doesn't count as income. And if you do the ordering right, it can satisfy an RMD. For example, let's say, your RMD for your IRA this year, if you're subject to them, is $5,000, and you normally give $5,000 to charity just to make a simple example. If you do the QCD, the transfer from your IRA to the charity for $5,000, you don't even have to take the RMD. It's satisfied at zero tax costs with a gift you would have been making anyway.

Benz:

So, just to ensure that that QCD qualifies and satisfies the RMD, is there anything people should know about that in terms of the logistics of executing this qualified charitable distribution?

Slott:

Yeah, even though it's a little after January, I'll give you my "January is the new December" rule. It's the "first dollars out" rule. Without getting too technical, the reason I say January is the new December: Traditionally, people think about gifting and charity in December holiday time. When it comes to QCDs, think about it early in the year, not late in the year. If you want to do what I just said, have your QCD or charitable transfer satisfy your RMD or any part of it--you can do more than the RMD or less, whatever you want, but if you want it to offset, like in my example, the RMD--take the QCD first, because under the tax rules, the first dollars out are considered to satisfy the RMD. So, in my example, if you took your RMD for 2022 of that $5,000 now early in the year and then said, "You know, I'd like to offset that with a QCD." You can't. You could still do the QCD, but you'll still have income on the RMD. Do the QCD first.

Benz:

You mentioned that more and more taxpayers are using the standard deduction, not itemizing. How about itemizers in the context of the QCD? Can they take advantage of this?

Slott:

Oh, yeah. The QCD doesn't stop you from itemizing. But even if you're itemizing, the QCD is better. I would do the QCD, if you qualify, and then, if you have bigger deductions that you can itemize, you can do that, because again, the QCD lowers adjusted gross income. Itemized deductions don't do that.

Benz:

But you can't double-dip, right, the same ... ?

Slott:

Not the same money. No, no. In fact, you may have seen a story, I think was in

The Wall Street Journal

or something where I was quoted on that. And they asked me, somebody wrote in, they said, "Well, I could do the transfer, take it as an itemized deduction and QCD." That's double-dipping. No, you can't do that.

Benz:

One thing I want to ask you about, Ed, is the documentation related to this QCD. If people get a 1099, will it show that they made a QCD? How do they prove that they took advantage of this mechanism?

Slott:

That's a great question. It won't show. You'll have to tell your tax preparer, or if you're doing your own taxes, you have to know. Now, in the past, I thought this was an error because anything that comes out of an IRA generates a 1099-R form. So, let's say, you did the QCD for whatever the amount is, you're going to get a 1099-R, but you know it's not includable in income. But it's not coded that way on the 1099-R. And recently, IRS came out and said, "That's intentional." That's not an oversight, because the institutions--the fund companies, the banks, brokers--that issue these, they don't want to be the police. They don't know if you have a qualifying charitable distribution. They don't know if it's a qualifying charity. So, they don't code it. You have to prove it with your own documentation, and let your tax preparer know that you've made that QCD and it qualifies.

Benz:

Ed, helpful rundown as always. Thank you so much for being here.

Slott:

OK.

Benz:

Thanks for watching. I'm Christine Benz for Morningstar.