By Sarah Brenner
Do you have clients with IRAs that are charitably inclined? If so, be sure to inform them about qualified charitable distributions (QCDs). If advisers overlook this powerful strategy, their clients can miss out on a useful tax break. Here are 10 things every adviser should know about QCDs.
1. A QCD is a way to move IRA funds to a charity, tax-free. When a QCD is done, the amount is excluded from income. Excluding the income is an even better tax benefit than receiving a tax deduction, because it keeps adjusted gross income (AGI) lower. This can allow a client to take advantage of more AGI–based tax benefits, resulting in a lower taxes. Many older clients no longer itemize and instead use the standard deduction. A QCD provides a way to still get a tax break for a charitable contribution. (However, no additional deduction can be taken for the charitable contribution when a QCD is done.)
2. QCDs are available to IRA owners and beneficiaries who are age 70½ and over. While the Secure Act has delayed the age when required distributions must start until age 72, the age for QCDs remains unchanged at age 70½. This requirement can be confusing for clients because it requires that the individual actually be age 70½ when the QCD happens. A QCD cannot be done earlier, even if the individual will reach age 70½ later in the year.
IRA beneficiaries can do QCDs, too. Many clients who inherit an IRA may not be aware of this. The beneficiary must be age 70½ and the age of the deceased IRA owner does not matter.
>>Plus, on Robert Powell's Retirement Daily: Secure Act 2.0 — Cascading Beneficiary Strategy for Married IRA Owners
3. Deductible IRA contributions after age 70½ can reduce QCDs. The Secure Act did away with the age limit for traditional IRA contributions. However, for those who make both QCDs and deductible IRA contributions, the rules now limit the portion of the QCD that is excluded from income, effectively creating a taxable QCD.
Advisers should tell clients not to make deductible IRA contributions after 70½ if also doing QCDs. The QCD tax benefit could be reduced. Older clients who do QCDs and want to make IRA contributions should be encouraged to contribute to Roth IRAs instead. Roth IRA contributions do not disrupt QCDs.
4. QCDs cannot be done from employer plans or active SEP or SIMPLE IRAs. Clients looking to do a QCD from their 401(k) or other employer plan will be out of luck. This is an IRA-only tax break and is unavailable from “active” SEP or SIMPLE IRAs. (A SEP or SIMPLE is active if a contribution is made for the year.) A possible workaround for advisers could be having the client do a direct rollover from the plan to an IRA or a transfer from the active SEP or SIMPLE to an IRA. Then the QCD can be done from the IRA.
Another restriction is that QCDs apply only to taxable amounts in IRAs. After-tax dollars in an IRA are not eligible, and any pre-tax IRA dollars are considered distributed first as the QCD. This is an exception to the pro-rata rules that normally apply to IRAs. As such, a QCD can be a good strategy to isolate after-tax basis in a traditional IRA and convert funds to a Roth IRA tax-free.
5. QCDs are capped at $100,000 per person, per year. There is no issue with smaller QCDs and no issue with multiple QCDs, as long as the total does not exceed $100,000. Some IRA custodians may have limits, however, on the size and number of QCDs. For a married couple where each spouse has a separate IRA, each spouse can contribute up to $100,000 from their own separate IRAs.
>> See: Five IRA Rules for Spouses
6. A QCD must be done via a direct transfer from the IRA to the charity. The funds must go directly. A client cannot take a distribution made payable to him and then give the funds to the charity. (Although a check made payable to the charity can be sent to the account owner for delivery.)
7. QCDs cannot be made to private grant-making foundations, donor-advised funds or charitable gift annuities. Be sure that clients understand these limitations. A QCD to an ineligible recipient will result in an unexpected taxable distribution.
8. A QCD from an IRA can satisfy a required minimum distribution (RMD). This is good news for clients who do not need their RMD or want the tax bill. However, the timing matters here. Once an RMD is taken, that income cannot be offset with a future QCD.
Advisers should identify all clients who might be eligible for a QCD and contact them before they make any moves. Recommend that the QCD be completed as early in the year as possible.
This will reduce the possibility of anyone missing the chance to offset RMD income with a QCD or the chance that one might be forced to take additional dollars later in the year.
9. The charitable substantiation requirements apply. Clients will want to keep good records in case the IRS has questions in the future. Advisors should monitor all clients who do QCDs to be sure that the charity provides a contemporaneous written acknowledgment by the time the tax return is filed. The contribution to the charity would have had to be entirely deductible if it were not made from an IRA. There can be no benefit back to the taxpayer.
10. There is no special code for a QCD on Form 1099-R. The fact that there is no special code on the 1099-R for custodians to report a QCD creates a golden opportunity for advisers to add value. During the busy tax season, without information showing up on Form 1099-R, tax preparers can easily miss a QCD on a tax return. This could result in in an erroneous taxable IRA distribution and no itemized deduction for the QCD (because the transfer went from the IRA directly to the charity and was missed by the tax preparer).
About the author: Sarah Brenner, JD is director of retirement education at Ed Slott and Company. She has worked for almost 20 years helping clients solve complex technical IRA questions. She has been a contributing writer for many IRA texts, articles and training manuals and has been quoted in national financial and tax publications such as CCH IRA Guide. She is an experienced speaker who has educated thousands of professionals in the financial industry including attorneys, CPAs, bankers, financial advisers, and brokers on retirement plan rules. Sarah has won praise for her ability to communicate complex laws in an easy-to-understand way and provide practical strategies for clients.
Sarah is a contributing writer and editor for Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisers nationwide, and writes for several areas of the company’s website, www.irahelp.com.
