You can make cash donations to IRS-approved charities out of your IRA using so-called "qualified charitable distributions" (QCDs). This strategy may be advantageous for high-net-worth individuals who have reached age 70 1/2. It expired at the end of 2014, but QCDs were made permanent for 2015 and beyond under the Protecting Americans from Tax Hikes (PATH) Act of 2015.
To take maximum advantage of this strategy for 2016, you'll need to replace some or all of this year's IRA required minimum distributions (RMDs) with tax-advantaged QCDs. Here are more details.
QCDs can be taken out of traditional IRAs, and they're exempt from federal income taxes. In contrast, other traditional IRA distributions are taxable (either wholly or partially depending on whether you've made any nondeductible contributions over the years).
Unlike regular charitable donations, QCDs can't be claimed as itemized deductions. That's OK, because the tax-free treatment of QCDs equates to a 100% deduction — because you'll never be taxed on those amounts. Additionally, you don't have to worry about any of the restrictions that apply to itemized charitable write-offs under the federal tax code.
A QCD must meet the following requirements:
Important note: You can also use the QCD strategy on an IRA inherited from the deceased original account owner if you've reached age 70 1/2.
There's a $100,000 limit on total QCDs for any one year. But if you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit, for a combined total of $200,000.
QCDs offer several potential tax-saving advantages:
In addition, suppose you've made nondeductible contributions to one or more of your traditional IRAs over the years. If so, your IRA balances consist of a taxable layer (from deductible contributions and account earnings) and a nontaxable layer (from those nondeductible contributions). QCDs are treated as coming first from the taxable layer. Any nontaxable amounts remain in your accounts. In subsequent tax years, those nontaxable amounts can be withdrawn tax-free by you or your heirs.
QCDs from Roth IRAs
Should you make QCDs from Roth IRAs? Generally, the answer is no. That's because you (and your heirs) can withdraw funds from a Roth IRA without owing federal income taxes. The catch is that at least one of your Roth accounts must have been open for five years or more.
Also, for original account owners (as opposed to account beneficiaries), Roth IRAs aren't subject to the RMD rules until after you die. The bottom line: It's generally best to leave your Roth balances untouched rather than taking money out for QCDs, because the tax rules for Roth IRAs are so favorable.
The QCD strategy can be a smart tax move for high-net-worth individuals over 70 1/2 years old. If you're interested in this opportunity, don't wait until year end to act. Summer is time for mid-year tax planning, including arranging with your IRA trustee or custodian for QCDs to replace your 2016 RMDs.
High-net-worth senior citizens who can afford to donate money from their retirement accounts may benefit tax-wise from taking qualified charitable distributions (QCDs) if they match at least one of these profiles:
1. You don't itemize deductions. Only people who itemize benefit tax-wise from regular charitable donations. Using QCDs provides a way for people who don't itemize to gain a tax benefit from making charitable donations.
2. You itemize, but part of your charitable deduction would be phased out based on your adjusted gross income (AGI) or delayed by the 50%-of-AGI restriction.
3. You want to avoid being taxed on required minimum distributions (RMDs) that you must take from your IRAs.