Escaping the tax on your RMD
Retirees of a certain age face the harsh reality that the IRS is lurking in the shadows. As soon as they turn 70 ½ years old, the IRS comes knocking. “Hello, Mr. Retiree,” says the nice IRS man. “You’ve had the tax-free use of this money for years and you have built up a nice little nest egg. Now we want our share.” They get their share by requiring you to take minimum distributions every year from your retirement savings. The distributions are taxed as ordinary income which makes the IRS man very happy.
Now what if I told you there was an easy and perfectly legal way to beat the IRS man at his own game? What if you could avoid paying any tax on your RMD this year and into the foreseeable future? If that sounds interesting, then you need to take a look at Qualified Charitable Distributions, or QCDs.
A QCD is a direct distribution from your IRA to a qualified public charity. Current tax law allows each qualified tax payer to make up to $100,000 in QCDs every year. QCDs satisfy your required minimum distribution but are not included on your tax return as taxable income. While this benefit sounds pretty good, there are a few important points to keep in mind.
First, you must be charitably inclined. With a QCD, the money you distribute must go directly from your IRA custodian to the qualified public charity. That’s why it is called a charitable distribution. If you distribute the money to yourself first and then donate it to charity, your distribution will be included in your taxable income for the year.
Second, you must be 70 ½ years old.
Third, your QCD must go to a 501(c)(3) tax exempt organization. Private foundations and donor-advised funds are not authorized to receive QCDs. If you make a distribution to a non-authorized charitable entity, your contribution may be tax deductible (if you itemize deductions), but the distribution itself will be counted as part of your taxable income.
Fourth, you cannot receive any benefit from the charity in return for your gift. Sometimes, charities provide incentives for making pledges. While a QCD can be used to satisfy your pledge, you would be on shaky ground to accept a special incentive gift of more than nominal value in exchange for your QCD.
Fifth, QCDs may only be made from an IRA or an inherited IRA, not from employer-sponsored plans like 401(k) or 403(b) plans or active SEP or Simple IRAs. (An active SEP or Simple is one still receiving contributions from employers.) However, you can make QCDs from “inactive” SEP or Simple IRAs that are no longer receiving employer contributions.
Current tax law makes QCDs attractive for two reasons. First, the new tax law requires folks to choose between receiving the larger standard deduction ($26,600 for couples filing jointly) or itemizing tax deductions. However, if you make your charitable contributions with QCDs, you effectively get both. You can claim the higher standard deduction and give pretax dollars to charities through the QCD.
QCDs also allow you to avoid the higher follow-on costs that come from showing more taxable income on your tax return. For example, Medicare premiums increase as your adjusted gross income goes up. Keeping your RMD out of your total income may help keep your Medicare premium down.
If you have already taken distributions from your IRA for 2018, you may need to wait until next year to benefit from the QCD. The IRS considers the first distributions in a year as counting toward that year’s required minimum distribution. However, if some portion of your RMD has yet to be distributed, you might want to discuss this strategy with your financial advisor.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.