As the year draws to a close, required minimum distributions (RMDs) and charitable donations are top of mind for many folks. Most people treat these as two separate issues, but I am here to advise thinking about them in tandem if you have both.
What are RMDs?
Tax-free growth in retirement accounts is great, but you cannot keep funds in those tax-advantaged accounts forever. Once you reach a certain age, you must begin drawing down the account. Your RMD is the minimum amount you must withdraw each year.
You can always withdraw more than your RMD, but additional amounts withdrawn in a given year do not count towards future RMDs.
If you were born in 1951 or later, you must generally begin taking distributions for the year in which you turn age 73. (If you were born in 1950 or earlier, the age trigger is 72.) However, there is a slight grace period: The deadline to take your initial RMD is April 1 of the following year. Afterwards, you must take your annual RMD by December 31.
For example, folks who were born in 1951 turned 73 in 2024. Their initial RMD (i.e., for 2024) is due April 1, 2025. They can take this distribution any time during 2024 or the first three months of 2025. Their RMD for 2025 is due December 31, 2025. They may take their 2025 distribution any time during 2025.
You can take your RMD in one lump sum or in multiple distributions throughout the year.
Your RMD for a particular year is based on the account value on December 31 of the prior year (certain adjustments may apply) and your remaining life expectancy. For instance, a person’s RMD for 2024 is based on their account balance as of December 31, 2023 (even if it is their initial RMD and not taken until early 2025).
If you have multiple accounts, you must figure the RMD for each account separately and add all RMDs together to determine your total RMD for the year. However, your total RMD need not come from each account ratably; you can withdraw the total RMD in any manner you wish, including all from one account.
Brokerages can automate the RMD process, saving you the hassle of figuring it out on your own.
How are RMDs taxed?
Retirement account distributions are included in your taxable income, with some exceptions. For instance, qualified distributions from Roth IRAs are tax-free. Distributions of previously taxed money (such as a basis in a traditional IRA) are also tax-free.
Can I avoid RMD taxation?
Do not skip an RMD to avoid paying taxes. Failure to take an RMD typically results in an excise tax penalty of 25% of that RMD, and with the balance remaining in your account you will have a higher RMD the following year. However, donating your RMDs is a legal way to avoid taxation if you follow the proper steps!
Most folks are familiar with the concept of tax deductions for charitable contributions. But a charitable contribution deduction only helps if you itemize deductions. If you take the standard deduction—which is a flat amount based on your filing status—rather than listing out-of-pocket medical expenses, state and local taxes paid, mortgage interest, charitable contributions, and certain other deductions, then a charitable contribution has no tax impact.
Enter the concept of qualified charitable distributions. A qualified charitable distribution (QCD) is an IRA distribution that is paid directly to an eligible charitable organization. IRA owners can take up to $105,000 in QCDs for 2024. (The limit increases to $108,000 for 2025.) You do not get a deduction for a QCD, but the QCD is not included in your taxable income (unlike a regular distribution). As a result, you get the tax benefit even when taking the standard deduction!
A few important notes about QCDs:
QCDs count towards your RMDs for the year.
Because QCDs reduce your account balance, you will have lower RMDs in future years.
You cannot make an “indirect” QCD. Once you receive an IRA distribution, it is included in your taxable income, even if you immediately donate the funds.
A lower “up-front” taxable income means less of your Social Security benefits are taxed and you are less likely to have increased Medicare premiums.
You can make a QCD to a public charity, such as a 501(c)(3) tax-exempt organization, but donor-advised funds, private foundations, and “supporting organizations” cannot receive QCDs.
How do I know if a qualified charitable distribution (QCD) is right for me?
If you are subject to RMDs, and regularly support charitable organizations, a QCD is probably right for you.
If you receive a $10,000 RMD, and then donate that money to your favorite charity, both you and the charity are in the same place from a cash flow perspective that you would be if your IRA custodian had instead transferred that $10,000 directly to the charity. But you do not need to itemize deductions to get the tax benefit of the charitable contribution when you use the QCD technique because the QCD is not included in your taxable income initially, and the exclusion of the QCD from your taxable income up-front yields other tax benefits as well.
Example 1 (donation of IRA distribution proceeds)
Pension income: $45,000
IRA distribution income: $10,000
Social Security (taxable portion): $12,000
Adjusted gross income: $67,000
Charitable donation: $10,000 (nondeductible since standard deduction)
Standard deduction: $16,550 (higher due to over age 65)
Taxable income: $50,450
Tax: $6,152
Example 2 (same as example 1, but donation made via QCD)
Pension income: $45,000
IRA distribution income: $0
Social Security (taxable portion): $11,000
Adjusted gross income: $56,000
Standard deduction: $16,550
Taxable income: $39,450
Tax: $4,502
Savings: $1,650
On the other hand, a QCD does not make sense if you would not otherwise support a charitable organization. Even though the QCD would save you money tax-wise, tax deductions only save you a percentage of the amount spent. In short, do not spend $1,000 to save $300 in taxes, because you are still out a net $700; only do it if you would spend that $1,000 anyway.
If you would like help figuring out whether a QCD is right for you, or you have other questions surrounding RMDs, reach out to me today to schedule a year-end tax planning meeting!
Comments