How to Get the Biggest Tax Savings on Year-End Charitable Donations

Tax savings via retirement accounts are great when you are accumulating wealth. However, the tax situation is not so fun when you are finally required to start making withdrawals based on your age. If you are charitably minded and looking to minimize taxes on your retirement account withdrawals, a strategy of qualified charitable distributions (QCD) may help you pay fewer taxes over your lifetime.

New clients of mine typically donate more than $100,000 per year to various charities. One of the reasons the couple hired me was because their previous basic financial advisor didn’t offer tax-planning advice or guidance. This lack of knowledge left my new clients overpaying their taxes each year and limiting the amount they felt they could afford to donate to charity. The extra $100,000 of realized income increased their Medicare premiums and pushed other income into higher tax brackets at both the state and federal levels. While you need to pay the taxes you owe on your income, there are no awards or benefits for leaving the IRS a huge tip.

Implementing a QCD strategy (for the charitable donations they planned to give anyway) allowed them to reduce their overall taxes, minimize their Medicare premiums, and get more value from the standard deduction each year. Suppose your financial advisor isn’t giving you valuable guidance on the taxation of your retirement income. In that case, it may be time to search for a financial advisor who better fits your needs.

What Exactly Is a Qualified Charitable Distribution?

What rules must you follow to get the various tax benefits from a qualified charitable distribution (QCD)? If you have an IRA, you may be able to exclude your required minimum distributions (RMDs) from your adjusted gross income (AGI) when the money is donated to a qualified nonprofit.

Following the QCD rules, you can give money from your IRA directly to the charity without first receiving it as income. This legal tax-planning strategy allows you to donate the total amount you withdraw from your IRA versus just what is left over after you have paid income taxes due to the federal government and your state.

There are a few hurdles before you can use this valuable tax-planning strategy. You can only begin using the QCD tax-planning strategy at age 70.5. The good news here is that you don’t have to wait until you are forced to start taking RMDs. And yes, QCDs can count as part of your required minimum distribution each year.

Congress made the qualified charitable distribution rule permanent in 2015. Given the current gridlock in Congress, I would be surprised if they could repeal this tax-planning strategy even if they wanted to.

How the QCD Tax Strategy Works

1. If you decide to make a QCD, choose a nonprofit and make sure that the charitable organization qualifies as such under IRS rules.
2. Let your IRA custodians know your intention to do a QCD. There will likely be a form to sign. If this sounds complicated, don’t worry. Your fiduciary financial planner should easily walk through this process.
3. Once you submit the request, your IRA custodian will send a check to the charitable organization on your behalf.
4. Make sure your tax preparer is aware you made a QCD to ensure you get all the tax benefits. Some tax forms around QCDs can be confusing, even for tax professionals.

All QCDs must be made directly from your IRA. You will not get these specific tax benefits if the funds are sent to you first and then you donate to the nonprofit.

What Assets Are Eligible for a QCD Distribution?

Any assets within your IRA are eligible to be distributed via QCDs. However, the IRS does cap the amount you can donate annually via QCD at $105,000 in 2024. This amount is tied to inflation and will increase over time. The 2025 QCD limits will be $108,000. Anything over this amount could still be tax deductible if taken as an itemized tax deduction.

Technically, QCDs do not give you more tax deductions when you file your taxes. But they reduce your AGI, often providing more tax savings.

The Exceptions to Assets Eligible for QCD

Nondeductible contributions are not eligible to be used for QCD distribution. The good news is that they are already considered a tax-free return on a cost basis, so you won’t owe taxes when you withdraw these funds.

Also, for married couples, you must take one QCD to cover the individual RMDs from each spouse. You can’t just take on a large QCD from one spouse to attempt to cover the aggregate household RMDs for the year.

The AGI Tax Advantages from QCDs

The QCD allows you to reduce your AGI through a charitable donation without having to itemize deductions. Individual taxpayers may deduct qualified charitable contributions of up to 100% of their AGI, and corporations may deduct qualified contributions of up to 25% of their taxable income. Donations must be made in cash, and the charitable organization must be a qualifying organization.

Because your AGI is used to determine your taxable income, having a lower AGI can help you to stay in lower tax brackets, reduce or eliminate the taxes due on your Social Security benefits or other income, and remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income driving up your AGI and then taking an itemized deduction for your charitable donations.

The age requirement for taking RMDs was recently raised to 73 from 72 as of Jan. 1, 2023. This applies to withdrawals from traditional IRAs, 401(k) accounts, and SEP-IRAs. RMDs are still not required for Roth IRAs.

Who Should Use the QCD Tax-Planning Strategy?

Will you get any benefits from making a QCD? Ultimately, it will depend on your specific situation. Using a QCD makes the most sense if:

• You don’t need the RMD money right now.
• Not making a QCD would put you into a higher tax bracket or make other income taxable.
• You want to minimize your RMD amounts in the future.
• You were expecting to make a charitable donation anyway.
• You donate to charity but don’t always itemize your tax deductions.

There are scenarios where an RMD may not be the best asset to donate. The example I see most is for people with highly appreciated stocks not held in a retirement account. You can donate highly appreciated stocks directly to a charity and avoid paying capital gains taxes. The tax deduction will be based on the current value of the stocks rather than what you paid.

When Can I Make a QCD from (IRA)?

You can make a QCD from your IRA once you have reached the age of 70 1/2.

If you are over age 70 1/2 and plan to give money to charity each year, it is likely in your best interest to consider making a QCD. The tax savings may allow you to make an even larger donation or have a little more retirement income left over for you to enjoy. If this sounds like you and your financial advisor has at least told you about this great tax strategy, it may be time to get some proactive tax-planning advice.

David Rae is a certified financial planner