Required Minimum Distributions Part 2 – How Qualified Charitable Distributions Can Minimize the Tax Impact of RMDs

As discussed in part 1, the IRS requires you to begin withdrawing a minimum amount annually from traditional IRAs (and from most 401ks) once you reach age 70 ½. These minimum withdrawal amounts are called Required Minimum Distributions (RMDs). If you are one of the 3.4 million Americans who turn 70 in 2018 and own one or more of these accounts, you know that RMDs are in your near future.

When RMDs are distributed from your retirement accounts, they are almost always subject to taxation as ordinary income. The rate is determined by your regular income bracket, after adding all IRA withdrawals to your other sources of income. But RMDs can have other consequences that you may not have thought of, such as subjecting you to higher Medicare premiums and exposing a higher percentage of your social security benefits to tax.

In 2018, if your adjusted gross income is above $85,000 (single) or $170,000 (married, filing jointly), you are subject to higher Medicare Part B and D premiums. Individuals over that threshold could see a “high income surcharge” of up to $428 a month for Part B coverage and up to $76 a month for Part D prescription drug coverage. Further, up to 85% of your social security benefits are subject to tax, depending on your income level, and RMDs can force you into a higher bracket for this purpose as well.

There is another big change affecting a lot of seniors in 2018. The increased standard deduction ($12,000 single and $24,000 married filing jointly) will mean that only a small fraction of you will be able to itemize deductions starting this year. Thus, you will get absolutely no benefit from the gifts that you give to your church and your favorite charity unless you make these gifts from your RMDs.

Take Advantage of a Qualified Charitable Distribution (QCD)

Thankfully, there is a mechanism available to seniors that helps with all of these issues. RMDs of up to $100,000 can be distributed tax free each year from your IRA as a “Qualified Charitable Distribution” (or QCD).

This can be done only if the following requirements are met:

  1. The distribution is made from an IRA;
  2. The recipient of the charitable contribution is a “public charity,” such as a church, hospital, public museum, or educational organization;
  3. The IRA owner is at least 70 ½ years old at the time of the gift; and
  4. The distribution
    1. Is made directly to the charity,
    2. Is otherwise fully deductible as a charitable contribution, and
    3. Would have otherwise been included in the IRA owner’s gross income.

RMDs cannot be distributed tax free from a 401(k) or from active SEP and SIMPLE IRAs. However, in many cases, funds can be rolled over tax free from one of these plans to a traditional IRA, after which a QCD could be made from the IRA.

Who Should Consider a QCD?

If you are at least 70 ½, typically make significant charitable donations in a year, and do not rely on all your RMD to pay living expenses, you definitely should consider a QCD. Not only do you get a direct tax benefit from the QCD (whether or not you itemize deductions), the amount of the contribution is excluded from your income, potentially reducing your Medicare premiums and lowering the tax on your social security benefits.

Don’t let the requirement to make the contribution directly from your IRA discourage you; most IRA custodians have a simple form to accommodate this. And your church would be happy to accept one large contribution per year, rather than weekly smaller contributions.

If you have additional question on any of the above information, or any other aspect of your wealth planning, please call us at (904) 807-2183, to arrange a conference with a board certified tax attorney.

Read Required Minimum Distributions Part 3 – Death of IRA Owner.