In 1974, the government created the ERISA laws. At
this point, IRAs were introduced as a way to incentivize people to save for
their own retirement. It was a tax deferred investment vehicle that
would allow the contributor to hold off on paying taxes until the money was
distributed. Little did people know at that time, the deal that was made
included a requirement that at some point during retirement, the IRA holder
would be forced to take distributions. Basically, the government was tired
of waiting on their tax money so they put a stipulation that money had to be
distributed so the government could collect their fair share.
Billions locked Away- and Not Needed
Zoom forward to today and there are billions of dollars
inside of IRAs that many IRA holders don't need access to right now.
Between their social security, pensions and other savings, they don't need to
access the money. However, every year they get a friendly reminder from their
advisor that they have to take money out or face a pretty stiff penalty from
the IRS. The penalty used to be as high as 50% of the amount that was
required to be distributed.
Changing Rules Around RMDs
In 2020, the government moved the original 70 and 1/2 RMD
age to 72, and currently it is 73 and will increase to 75 by 2033. Part
of this included a new requirement that beneficiaries must fully distribute the
IRA within 10 years. In the past, inherited IRAs had adjusted RMDs for
the beneficiaries but most IRA holders were able to perpetuate their accounts
by growing more than the required distribution amount. The government did
not like that people could ensure that these funds would pass from generation
to generation as a tax deferred vehicle that only had a nominal distribution
requirement. Therefore, now, all IRAs have to be $0 within 10 years of
the original owner passing away.
The Tax Burden in Retirement
Many savers are beginning to regret the tax deferred aspect
of this vehicle because they are now paying more taxes than they did prior to
retirement. Some have suggested to just take all of the money out, pay
the taxes, then choosing something else to do with the money. Some want
to pass it to their heirs and others want to donate the money. The
problem with all of these decisions is that once the money comes out of the
account, the owner pays their current tax rate off the distribution and in some
cases, they get bumped to the next tax bracket.
Enter the QCD I A Tax- Savvy Solution
There is one trick that a lot of people are starting to take
advantage of inside of their IRAs. One can do a direct charitable
contribution from their IRA to a charity of their choosing. As long as
the owner is at the age of RMDs, which is currently 73, this would qualify for
their RMD for the current year. Since it is a charitable contribution
and it goes directly to the charity, they do not have to pay taxes on the
money. It is called a Qualified Charitable Distribution (QCD). It
is important to review this option with the CPA or accountant who does taxes
and make sure the trustee of the IRA will process it correctly.
A Real-World Example
Using practical dollars, if a person has $1,000,000 in an
IRA and they are currently 73, the RMD would be approximately $37,736. If
the owner is in the 20% tax bracket, then they would pay over $7500 in taxes to
take the $37,736 out of their account ($37,736 x 20% = $7,547.20) However, if
they utilized the QCD, they are able to donate the full $37,736 to their
charity, not pay any taxes or bump into the next tax bracket and all of their
money goes to the charity. By doing this people are able to give to a
charity and avoid taxes and their RMD.
QCD Rules You Need to Know
There are a few rules regarding QCD to be aware of.
For one thing, the max that one can do for a QCD is $108,000 in 2025 for an
individual ($216,000 for couples as long as $108,000 comes from each of their
own IRA accounts). The distribution can only come from a Traditional IRA,
Inherited IRA, or inactive SIMPLE and SEP IRAs. The donation has to go to
an eligible 501(c)(3) charity so it can't go to a private foundation or
donor-advised fund. The owner must be at least 70 and 1/2 to do the
distribution. Even though RMDs do not start until age 73, QCDs are not
allowed for people under 70 and 1/2.
Extra Benefits of QCDs
A few bonus items is that a QCD does not count against the
tax payer's AGI (Adjusted Gross Income) so they will not jump tax brackets with
the distribution. The tax payer does not need to itemize deductions to receive
the tax benefit nor does this count against the charitable deduction limits.
It truly is a win-win for the
saver who wants to avoid taxes on the IRA money that they do not need access to
at this time. This way, the IRA becomes the gift that truly keeps on
giving.
