A required minimum distribution (“RMD”) is a mandatory withdrawal from an individual retirement account (“IRA”) that counts as part of your annual taxable income. The main point of RMDs is to keep IRA money from staying tax-free forever – contributions to an IRA are tax-deductible to encourage retirement savings, but the taxes need to be paid eventually. RMDs essentially kick money out of an IRA so the government can tax you on it, even if you don’t want or need the funds.
RMDs currently start when you turn age 72 (or at age 70 ½, if you turned 70 ½ prior to January 1, 2020) and are generally calculated by dividing the prior December 31 balance of that IRA account by an IRS-published life expectancy table. Each year an IRA owner needs to withdraw a certain percentage of their account, and that withdrawal percentage increases as they age. It’s important to note that RMDs do not need to be spent, many Charter Oak clients simply reinvest their RMDs in a taxable investment account.
Naturally, RMDs can be a tax burden to those who already have enough money, sometimes boosting their annual income into a higher tax bracket, potentially triggering phaseouts that limit or eliminate some deductions, and can mean higher taxes on Social Security income. Unfortunately, skipping RMDs comes with a steep 50 percent (of what you were supposed to withdraw) penalty. For example, if you skip a $20,000 RMD it is corrected by both taking the $20,000 withdrawal AND paying a $10,000 penalty.
Using Qualified Charitable Distributions
to Manage your RMDs
Qualified Charitable Distributions (“QCDs”), a.k.a. IRA charitable distributions or IRA charitable rollovers, allow individuals to satisfy their annual RMD and exclude the QCD amount from their adjusted gross income by a direct transfer of up to $100,000 per year to a charity or multiple charities, so long as the total does not exceed $100,000. For married couples, each spouse can make QCDs up to the $100,000 limit for a potential total of $200,000.
Because QCDs reduce an IRA balance they may also reduce an individual’s RMD in future years. Moreover, QCDs are not counted toward the maximum deductible for those who itemize their annual giving, QCDs are above and beyond those limits. This can allow a QCD donor to stay in a lower tax bracket, reduce or eliminate taxation of Social Security or other income and remain eligible for deductions or credits that might be lost if the RMD were considered income.
QCDs are made directly to an eligible charity from a Traditional IRA, Inherited IRA, inactive SEP or inactive SIMPLE IRA. The distribution must be paid directly to the charity from the IRA custodian, i.e. the IRA distribution check must be made out to the charity or it will be considered taxable income. The QCD must also be made by December 31 of the tax year it will apply to. Charter Oak’s advisors recommend our clients keep good records of their annual QCDs to share with their tax preparer, as IRA custodians do not summarize these charitable distributions on annual tax statements.
Importantly, QCDs can only be made to qualified 501(c)(3) charitable organizations as defined by the IRS (donor-advised fund sponsors, private foundations and supporting organizations are excluded) and donors cannot receive any benefit in exchange for making a QCD to a charity (tickets to an event, winning bid on a charity auction item).
As you can tell, QCDs can offer several benefits and may be ideal for donors who:
- Don’t need their RMDs and whose taxes will increase if RMDs are considered income.
- Want to lower their IRA balance to minimize future RMDs.
- Would like to make a larger charitable gift than if they simply donated cash or other assets.
- Do not want to contribute to a foundation or donor-advised fund.
- Know which charities they want to support with such a gift.
If you have yet to take your RMD for 2021, please be assured that your Charter Oak team will be in touch to complete your RMD before the year draws to a close. The 2020 CARES Act waived RMDs for 2020, but there is no such waiver for this tax year.
Finally, we encourage you to consider a QCD if you are charitably inclined and have the means to do so -- because giving makes you feel good, it strengthens your personal values, introduces your family to the importance of generosity and encourages others to do the same. As always, it is a pleasure and privilege to serve you.