By Allison L. Lee
You may already be aware of the moderate reduction in required minimum distributions (RMDs) as a result of the new life expectancy tables issued by the IRS in 2021. The new tables used to compute the RMDs beginning in 2022 are likely to result in a smaller income tax bill for you. But if you don’t yet need the money you’re required to withdraw, you may consider the tax hit a nuisance. Can the money you’re forced to withdraw be put to more productive use?
If you’re charitably inclined — as many retirees are — there is another way to further maximize your tax savings in relation to your RMDs: You can make qualified charitable distributions (QCDs). And there is a tax-wise reason for making them now rather than later in the year.
A QCD is a transfer of funds from your IRA directly to a qualifying nonprofit organization. QCDs count toward your RMD (up to $100,000 a year), allowing you to fulfill your RMD obligations without increasing your taxable income. This makes QCDs an effective and tax-advantaged giving option for individuals who aren’t dependent on their RMDs to maintain their lifestyle.
If you are fairly confident you’d like to make a QCD in the current tax year, it’s smart to do so earlier in the year rather than, say, the holiday season, when many people ultimately follow through with their charitable giving intentions. This is because the first dollars you withdraw from an IRA count toward your RMD, even if you make a QCD later in the year. This is sometimes referred to as the “QCD tax trap.”
Consider this scenario: Say you have a $50,000 RMD this year. Knowing this, you withdraw $30,000 early in the year, which is counted toward your RMD because of this “first dollars out” rule. Several months later, you decide to make a $50,000 QCD to your favorite charity. That QCD helps you satisfy your RMD obligation, but it is counted after the $30,000 you took out for yourself earlier in the year. That $30,000 will be taxed as income, whereas if you had made the $50,000 QCD in lieu of the prior withdrawal, you would have completely satisfied your RMD (and not been required to withdraw any additional funds).
More than 10,000 baby boomers become QCD-eligible every day. If you’re subject to RMDs and are philanthropically motivated, making a QCD can be one of the most tax-advantaged ways to support the causes that matter to you. And if you’ve committed to making a QCD, doing so now can help ensure that you receive the tax benefit and avoid falling into the QCD tax trap.
To make a QCD, you must fill out an IRA Charitable Distribution form unique to your IRA custodian. You can reach out to your IRA custodian directly to facilitate the process. Alternatively, you can ask your tax or financial advisor for assistance getting the process started.
About the author: Allison L. Lee
Allison L. Lee is the associate general counsel for FreeWill, a mission-based public benefit corporation that partners with nonprofits to provide a simple, intuitive and efficient platform to create wills and other estate planning documents free of cost. Through its work democratizing access to these tools, FreeWill has helped raise more than $4 billion for charity.
Allison also oversees FreeWill’s Fellows Program, a network of trust and estate practitioners from across the country who are passionate about improving access to law and increasing the role of charitable giving in estate planning. Prior to joining FreeWill, Allison spent more than a decade in private practice (most recently at a New York law firm), was rated by Super Lawyers (Rising Stars) in the area of estate planning and probate, and is a member of the New York, New Jersey, Florida, Maryland and Washington, D.C. bars.