Disciplined retirement saving, coupled with smart investment management, has created a big tax problem for a small group of IRA owners. At age 72 or older, IRA owners are required to take minimum distributions even if they don’t need the money to meet current living expenses, creating an unwelcome and potentially significant tax liability.

Thanks to a little-known provision in the tax code, the income tax exposure of required minimum distributions (RMDs) is avoidable by making a charitable donation through a QCD, or Qualified Charitable Distribution.

What is a QCD?

A QCD is a direct transfer of IRA funds (including SEP-IRAs and Simple IRAs) to a qualified charity.

The amount transferred to a qualified charity may be used to satisfy all or a part of an individual’s RMD—up to a maximum of $100,000—and must be made by the RMD deadline, which is generally Dec. 31. Additionally, if it is a joint tax return, spouses may also make a QCD of up to $100,000. QCDs in an amount in excess of an RMD do not count toward the following year’s RMD requirement.

The QCD must be a direct transfer; any distribution made to an IRA owner and then forwarded to a qualified charity does not qualify as a QCD.

Why A QCD?

The additional income represented by an RMD can be costly to individuals by pushing IRA owners into a higher tax bracket; this not only takes a bigger bite out of household income, but may also adversely impact Social Security and Medicare benefits.

Because a QCD is not reported as taxable income, the distribution does not result in any tax liability for the IRA owner, keeping the IRA distribution from lifting an individual into a higher tax bracket and avoiding any undesirable effects on Social Security or Medicare benefits.

What About Donor-Advised Funds?

Many charitably-inclined individuals may have already established a donor-advised fund—a charitable vehicle that provides them with greater control over the amount and timing of any charitable bequests, as well as how the funds are managed.

Unfortunately, a QCD cannot be made to a donor-advised fund. However, an IRA owner’s donor-advised fund (or Charitable Remainder Trust) may be designated as beneficiary on an IRA.

IRA owners who may be considering a QCD or designating a charity as their IRA beneficiary should consult an experienced tax advisor to understand the tax implications specific to their personal situation.

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