Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (0123-3U8P)
For retirees who've accumulated significant savings in their tax-deferred accounts, the onset of required minimum distributions (RMDs) at age 72 can have serious tax consequences. "The higher the balance in your tax-deferred accounts, the higher your RMDs—and potentially your tax bracket," says Hayden Adams, CPA, CFP®, director of tax and wealth management at the Schwab Center for Financial Research.
If charitable giving is part of your financial plan, a qualified charitable distribution (QCD) can further your philanthropic goals and help reduce the tax hit from your RMD.
QCDs allow individuals age 70½ and older to make tax-free donations of up to $100,000 a year directly from an IRA to a qualified charity, thereby satisfying all or part of their annual RMDs. "QCDs don't count as income—meaning you can't deduct the contribution on your tax return—but their tax benefits could outweigh those of donating cash or other assets to charity," Hayden says.
For example, let's say you're 75 years old and single, and you need $125,000 in income this year. You're required to withdraw $110,000 for your annual RMD and will receive another $50,000 of taxable income from a pension and Social Security—pushing your total taxable income to $160,000. By making a QCD equal to your excess income ($35,000), you could potentially pay $3,408 less in taxes than if you took the full RMD and donated the cash after the fact.
Cash vs. QCD
Taking your full RMD and then donating cash could result in a higher tax bill than if you were to give through a QCD.
Scenario 1
Take full RMD and donate $35,000 in cash
Nonportfolio income: $50,000
Annual RMD: + $110,000
QCD: $0
Pretax income: = $160,000
Itemized deduction: – $35,000
Taxable income: = $125,000
Estimated taxes due: $23,716
Scenario 2
Donate $35,000 of RMD directly to charity using a QCD
Nonportfolio income: $50,000
Annual RMD: + $110,000
QCD: – $35,000
Pretax income: = $125,000
Itemized deduction: – $14,700
Taxable income: = $110,300
Estimated taxes due: $20,308
Note: Illustration is for example purposes only and is not intended to be tax advice. RMD amount is approximate and assumes an IRA balance of $2.5 million. Tax calculations are estimated using 2022 federal tax brackets, do not reflect state taxes, and assume that 85% of Social Security benefits are taxable. In 2022, the standard deduction for a single filer age 65 and older is $14,700 ($12,950 standard deduction plus $1,750 additional standard deduction).
"That said, you don't necessarily want to give away money just to get a tax break," Hayden says. "But if philanthropy is already part of your financial plan, a QCD can be a great way to optimize the tax benefits of giving."
Find your Required Minimum Distribution.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
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