Why charitable individual retirement account transfers should be the ‘first source of giving’ for certain retirees

If you’re retired and giving to charity this holiday season, experts say there’s a way to trim your 2022 tax bill while supporting your favorite cause.

Despite economic uncertainty, the majority of American adults plan to donate similar amounts this year as they did last year, a recent Edward Jones study found.

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While tax breaks aren’t typically the prime reason for giving, retirees may consider using qualified charitable distributions, or QCDs, which are direct gifts from an individual retirement account to an eligible charity.

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“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.

If you’re age 70½ or older, you may donate up to $100,000 per year, and it may count as a required minimum distribution if you transfer the money at age 72. While the maneuver doesn’t provide a charitable deduction, you may see other significant tax benefits, financial experts say.

The primary benefit of a QCD is that the transfer doesn’t count as taxable income, Foster 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, he said.

What’s more, 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 who founded 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. If you itemized deductions, you 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 the transfers aren’t separated on Form 1099-R, which reports retirement plan distributions to the IRS. 

For example, if you withdraw $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 you write a check from your IRA to a charity at the end of December, it must clear from your IRA by Dec. 31 to count for the year, May said.

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