Retirement planning has a lot of moving parts. You can be charitably inclined and save money on your taxes at the same time. On the Secure Your Retirement podcast, we’ve discussed Qualified Charitable Distributions (QCDs) and Donor Advised Funds. As we approach the end of the year, let’s take some time to revisit this strategy.
What are QCDs and How Do They Work?
QCDs often pop into a client’s mind close to the end of the year. If you’re charitably inclined, you can use a QCD to benefit from the donation. For example, instead of giving cash from your bank account to a charity, the money comes from an IRA.
The IRA sends the money directly to the charity on your behalf – it never touches your account. This is very important.
So, what’s the benefit of a QCD? A dollar-for-dollar tax deduction. If you do this correctly and before the end of the year, you don’t need to pay taxes on the money donated. Typically, a traditional IRA is taxed when the money comes out of the account. A QCD goes directly to the charity, so you avoid any taxes on this distribution.
If you plan on giving money to a charity anyway, this works in your favor.
When Can You Start Doing QCDs?
QCDs are only available to those who are 70-½ or older. This is the age when you start to take a required minimum distribution (RMD). When you hit this age milestone, you can start QCDs. If you’re not at this milestone, our next section can help.
For QCDs to work in your favor, you must distribute the funds properly: from the IRA made out to the charity directly. Otherwise, you will be taxed on the money going from the IRA to your own account.
Required minimum distributions (RMDs) are an important factor here. The IRS wants you to pay taxes on the pre-tax accounts, so they’ll require you to take distributions. If you have money coming in from multiple sources and don’t need the money from the RMD, a QCD may be in your best interest.
QCDs apply to your RMD amount.
If you have an RMD of $40,000 per year, you need to pay taxes on this amount. Donating $25,000 from your RMD using QCDs will allow you to pay taxes on just $15,000 instead. You may be able to donate the total amount, too.
What are Donor Advised Funds and How Do They Work?
Before going deeper into donor advised funds, it’s crucial to really understand itemized deductions and how they relate to your taxes. For example, let’s assume that you donate to a charity each year, even if it’s not part of a QCD.
Let’s assume that you give $15,000 per year to charity.
Itemizing your taxes only makes sense if you have $28,000 in deductions because it’s more than the standard deduction. If you give money to charity and can’t itemize on your taxes, you won’t benefit from the donation.
You can use QCDs in this case or you can “stack your donations.” What does this mean? Stacking can be set up in a donor advised fund. You can say, “I know for the next three years, I’m going to donate $15,000 each year.”
So, you can stack these donations into a fund that has $45,000 in it.
Since the $45,000 is higher than the $28,000 standard deduction, you can now itemize your deductions and save money on your taxes. You have control to:
- Donate the money as you please
- Choose any charity (or multiple ones) you want to donate money to as time goes on
Setting up these types of accounts is also very simple and straightforward. Charles Schwab, and a lot of custodians, have donor advised funds that are easy to create. However, once you earmark the money for charitable causes and put it into one of these accounts, it’s irrevocable.
Most accounts are very flexible and even allow you to donate amounts as low as $25.
You have a lot of flexibility in how the funds are dispersed, so you can donate to charities that you have a passion for and don’t need to be concerned about pre-planning which charities you want to support.
Funding one of these accounts can also be done strategically to save you even more on taxes. We often like to take a client’s highly appreciated stocks and fund the account with these stocks. Why?
You can lower the amount of stock you have through gifting. Perhaps you donate $45,000 worth of Apple stock to the fund. Once the stock is in the fund, the fund can sell the stock. The fund doesn’t need to worry about capital gains or tax complications.
Funding the donor advised fund with a long-term capital gains stock can help you lower your taxable income and take tax deductions through itemization.