Avoid This QCD Mistake

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The qualified charitable distribution is a great way to be charitable and get a tax benefit. But not everyone who wanted to take advantage of the QCD in 2018 was able to. Joining me to share some perspective on this issue is retirement expert, Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Great to be here live in Chicago at Morningstar.

Benz: It's always a treat to have you here. Let's talk about the QCD in 2018. You said some people who wanted to take advantage of it were not able to do so. Let's talk first about what the QCD is and then get into what tripped some people up for 2018.

Slott: Right. It's basically a rollover where you move money from your IRA directly to a charity and it's excluded from income. The only negative about it is that many people don't qualify. The only people that qualify--first of all, it's only for IRAs, not for plans. People got mixed up with that.

Benz: No 401(k) assets.

Slott: No 401(k), right. And you actually have to be 70.5. Not the day before you are 70.5. You actually have to be 70.5, and it's only for IRAs. So, that's a limited audience. But even among that audience, you can exclude that income, the amount you give to charity from income, and that lowers what's called your adjusted gross income, which is a key item on your tax return that many other tax benefits, deductions, and credits are based on. Now, this was a fabulous benefit in light of the new tax law as many people saw it from their returns in '18, because they got the extra standard deduction, the higher standard deduction. But if you take the standard deduction, you don't get to deduct your charity. But with the QCD, many people got the extra--when I say "the extra," the larger standard deduction--and an extra standard deduction. That why I said "extra," because there's a special extra deduction for people 65 and over. And obviously, if you are over 70.5, you are over 65. That wasn't a trick question. So, they got their deduction, plus the QCD additional on that. And the QCD is better than a deduction because it's an exclusion from income.

Benz: So, generally speaking, if you are a charitably inclined individual who is subject to RMDs on your IRA, you are better off giving to charity through the QCD than you are taking the money out and then sending some funds from your taxable account and then trying to itemize.

Slott: Yes, for a couple of reasons. Because if you do the QCD, as I said, you exclude it from income. And if you do it the other way, the old way, and you write checks, they may not be deductible if you are taking the higher standard deduction.

Benz: So, let's talk about how some people were disappointed in not being able to take advantage of the QCD. You think timing is really key. So, what are the key things to think about if I'm someone who is subject to RMDs and I want to take advantage of the QCD? What should I bear in mind?

Slott: Well, the mistake was: People you said that didn't take advantage of it--they did take advantage of it, but they did it the wrong way, their timing was off, and they didn't get the benefit. The benefit is to exclude it from income and have that count towards your RMD, so you don't have to report that as income. What some people did not know, many people did not know, including lots of tax preparers, there's a rule in there called the first dollars out rule, which means, the first dollars in a year--once you are in a required distribution year from your IRA over 70.5, the first dollars out, however they come out, are deemed to go towards satisfying the RMD. So, some people took their RMDs, their required minimum distribution, and then did the QCD. Well, you can't offset--the big benefit is to offset that RMD income excluded from income. If the first dollars out go to the charity, that's how you get the benefit. But some people didn't know that, so they took their RMDs, say, in March, April, May, anytime during the year, and they did like most people--They saved up their charity till November, December, when most people give to charity. So, they thought they could offset from the RMD, but the RMD came out first, so that had to be included in income. Now, what they sent to the charity still gets excluded from income, but they could have excluded the RMD.

Benz: So, you say that people who are going to take advantage of the QCD, if they are pulling any money out of the IRA and they want to do the QCD, make that the one that is QCD funds?

Slott: That should be the first dollars out until you satisfy the RMD. And another thing people didn't realize--people thought they were limited to the RMD. So, they may have wanted to give larger amounts to charity, but they thought they were limited. For example, if their RMD was $10,000, they felt they could only give $10,000 that way. That's not the case. You can give more than your RMD. You can give up to $100,000 a year.

Benz: That's a good point. Another question that comes into play relates to the first RMD. How does that factor into the QCD? So, once you're 70.5, your first year of RMDs, what should you know?

Slott: Yeah, that's a good point. Because when you turn 70.5, your RMD year is the year you turn 70.5. So, if you turned 70.5 in July, let's say, any money you take that year, even if it's before you turned 70.5, counts towards your RMD. But for the QCD, you have to actually be 70.5. So, what I would say for people who are doing it for their first year, don't take any money out until you are actually 70.5. And if you want to do the QCD to give to charity, make those the first dollars out but after you actually turn 70.5.

Benz: Another thing that comes into play is, some people are complaining that their 1099s were incorrect or confusing. What's going on there in relation to QCDs?

Slott: Yeah. There's no coding on a 1099. Every 1099-R has all kinds of numerical and alpha codes to tell the government what kind of distribution it is. There is no code, there never was for some reason, for a QCD. So, you have to know. So, it might look to your tax preparer even if you are doing your returns yourself, that, hey, they didn't mark this as a QCD. No, you have to do that when you file your return. So, your distribution will look like any taxable distribution. You actually have to go into your return and write "QCD"--not write, nobody does, well, some people do it by hand, but not many anymore. You put in the code "QCD," and it shows correctly, and the amount you gave to charity will be properly excluded from income. But if you just look at that 1099, it looks like you didn't do anything.

Benz: So, presumably, I'd need some supporting documentation from the charity, too, right?

Slott: Right. Just like you would for any charitable gift.

Benz: And you noted also that the QCD can exceed the RMD, so don't be limited to that, but you can only go up to $100,000.

Slott: That's a pretty big limit, and that's per person. But you can't use--we got this question, too--if you have two spouses, they want to give a lot; one spouse gives 100[,000], but the other spouse doesn't give any. Well, the first spouse can't--it's not transferable. The "I" in IRA stands for individual; it's only yours.

Benz: Ed, always great to get your thoughts. Thank you so much for being here.

Slott: Thanks, Christine.

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