Here’s a tax-smart charitable giving strategy using money from an IRA

Over the past few years, there has been no shortage of ways to give to charity. And there’s special tax relief for retirees who transfer funds from Individual Retirement Accounts.

Americans gave about $326.87 billion to charity in 2021, an increase of 4.9% from the previous year, according to Giving USA.

Whatever cause they’re looking to support, philanthropic retirees can consider a strategy known as qualified charitable distributions, or QCDs, experts say.

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QCDs are direct donations from an IRA to a qualifying charity. If you’re 70½ or older, you can donate up to $100,000 a year, and that can count as a required minimum distribution once you turn 72.

Although the maneuver does not provide a charitable deduction, you may see other significant tax benefits, according to financial experts.

“For most people, most of the time, it’s going to be best if it’s your first source of charitable giving,” said certified financial planner David Foster, founder of Gateway Wealth Management in St. Louis.

The main advantage of a QCD is that the transfer does not count as taxable income, he said.

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

Additionally, a QCD reduces their IRA balance, reducing the size of required future 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 just because of tax breaks, QCDs can offer a big one: lower adjusted gross income.

“It’s important because [higher] adjusted gross income often has many other tax ramifications,” said JoAnn May, CFP and CPA who founded Forest Asset Management in Berwyn, Illinois.

For example, more adjusted gross income can lead to higher monthly premiums for Medicare Part B and Part D, she said.

The surcharge, known as the Income-Related Monthly Adjustment Amount, or IRMAA, adds additional fees for a year once income rises above a certain level.

“IRMAA is a big deal with my retired clients,” May said. “They don’t like to pay.”

Another example is the write-off of medical expenses. Those who itemize deductions can claim tax relief for qualifying expenses that exceed 7.5% of adjusted gross income. However, higher income creates a bigger barrier to claiming the deduction, she said.

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

For example, if you withdraw $50,000 per year and $20,000 is for a QCD, the form will still show $50,000 in total distributions, even if 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 IRA payment must be made to the charity. If you write a check from your IRA to a charity in late December, it must be withdrawn from their IRA by December 31 to count for the year, May said.

Retirees, however, can get around the problem by having their caretaker sign the check.