Retirees may save with this year-end charitable donation tax strategy

As the year winds down, retirees eager to make charitable gifts may consider a tax-friendly donation from their individual retirement account. 

The strategy, known as a qualified charitable distribution, or QCD, involves a direct payment from an IRA to an eligible charity.

Retirees who are age 70½ and older may transfer up to $100,000 per year, and someone who is age 72 may use a QCD to satisfy their required minimum distribution.  

“For most people, most of the time, you’re going to be better off doing this as your first source of charitable giving,” said certified financial planner David Foster, founder of Gateway Wealth Management in St. Louis.

The primary benefit of a QCD is that the transfer won’t be counted as taxable income, he said.

Since fewer Americans itemize deductions, it can be difficult to claim a write-off for charitable gifts. However, retirees taking the standard deduction may still benefit from a QCD because it won’t be part of their adjusted gross income, Foster said.

Moreover, a QCD reduces their IRA balance, cutting the size of future required minimum distributions, he said.  

“That’s a relatively small benefit for most people but still relevant,” Foster added.

While most people don’t make charitable donations solely because of the tax breaks, QCDs may offer a big one: reducing adjusted gross income.

“That’s important because [higher] adjusted gross income often triggers a lot of other tax ramifications,” said JoAnn May, a CFP and CPA with Forest Asset Management in Berwyn, Illinois.

For example, more adjusted gross income may cause a hike in monthly premiums for Medicare Part B and Part D, she said.

The surcharge, known as the Income Related Monthly Adjustment Amount, or IRMAA, adds an extra fee for a year once income exceeds a certain level.

“IRMAA is a big issue with my retired clients,” May said. “They don’t like paying it.”

Another example is the medical expense write-off. Those who itemize deductions may claim a tax break for qualified expenses that exceed 7.5% of adjusted gross income. However, higher income creates a steeper hurdle to claim the deduction, she said. 

One of the biggest issues with QCDs is that the transfers aren’t separate on Form 1099-R, which reports retirement plan distributions to the IRS. 

For example, if someone withdraws $50,000 in a year and $20,000 is for a QCD, the form will still report $50,000 in total distributions, even though only $30,000 is taxable income, Foster said. 

“It’s up to you to keep track of how much of that money went directly to charity,” he said.   

Additionally, the payment from the IRA must be made out to the charity. If someone writes a check from their IRA to a charity at the end of December, it must clear from their IRA by Dec. 31 to count for the year, May said.

Retirees, however, may bypass the issue by having their custodian cut the check.