Exploring the potential of your inherited IRA can lead to surprising opportunities, especially when it comes to charitable giving. One such opportunity is the Qualified Charitable Distribution (QCD), a tax-savvy way to support causes you care about while fulfilling your obligations as an IRA owner.
In this post, we’ll dive into the necessary steps of making a QCD from an inherited IRA, helping you understand the benefits, rules, and strategies that can make this a powerful tool in your financial planning. Whether you’re familiar with the concept or just beginning to explore it, this guide will provide the clarity you need to make informed decisions.
What is a Qualified Charitable Distribution (QCD)?
A qualified charitable distribution QCD lets you donate directly from your IRA account to a qualified charity, keeping those funds out of your taxable income. This approach can help prevent you from moving into a higher tax bracket, which often happens with typical IRA withdrawals.
To take advantage of a QCD, you need to be aged 70½ or older. You’re allowed to give a set amount per tax year through this method, and you’re free to split that amount among multiple charities if you wish. The key requirement is that the donation goes directly to the charity—handling the funds yourself disqualifies the distribution as a QCD.
The tax benefits of making a QCD are compelling. Since the amount isn’t counted as income, it can lower your overall gross income, potentially reducing the impact on your tax credits and deductions. This makes QCDs an attractive strategy for anyone looking to make a charitable gift while also managing their tax return effectively.
Please Note: For 2024, the QCD limit is $105,000. However, this limit is altered each year as the number is indexed for inflation. 1
Understanding Inherited IRAs
An inherited IRA is an IRA that you receive when someone passes away, leaving you as the beneficiary. These accounts operate under different rules compared to traditional IRAs. For example, if you inherit an IRA, you can be required to begin taking required minimum distributions RMDs, regardless of whether you’ve reached the specified RMD age of 73. The timing and amount of these distributions can vary depending on your relationship to the account’s original holder.
There are several distinctions between inherited IRAs and traditional IRAs. While the owner of a traditional IRA can wait until age 73 to start taking RMDs, beneficiaries of inherited IRAs may need to begin withdrawals much earlier, depending on their status as a spouse, non-spouse, or other type of beneficiary. Additionally, you cannot contribute new funds to an inherited IRA, which is another significant difference from traditional IRAs.
Can You Make A QCD From An Inherited IRA?
Yes, it is possible to make a qualified charitable distribution QCD from an inherited IRA, but there are specific criteria to meet. The IRA beneficiary must be at least age 70½ or older to be eligible for a QCD. If you’re under 70½, any withdrawal from the inherited IRA will be treated as taxable income rather than a QCD that is tax-free.
When considering a QCD from an inherited IRA, the ages of both the original IRA owner and the current beneficiary are important. While the original account holder’s age might impact required minimum distributions (RMDs), the beneficiary’s age is what determines whether a QCD is possible. This distinction is key, especially if the previous owner was already using QCDs for their RMDs—the rules for the inherited account now revolve around the beneficiary’s age and tax obligations.
Advantages of Using QCDs with Inherited IRAs
A qualified charitable distribution QCD from an inherited IRA can be a powerful tool in your tax strategy, offering several advantages that extend beyond charitable giving. Let’s break down the primary benefits:
- Tax efficiency: Donating pre-tax dollars directly from your IRA to a qualified charity helps lower your taxable income. This approach allows you to contribute to charity without increasing your tax obligations, which is particularly useful if you’re trying to stay within a certain tax bracket.
- Satisfaction of RMDs: QCDs can fulfill your required minimum distribution (RMD) obligations. By sending your RMD directly to a charity, you meet your distribution requirement without adding to your taxable income, which could otherwise increase your tax burden.
- Potential tax bracket benefits: By preventing extra taxable income through QCDs, you might be able to maintain a lower gross income. This can help you avoid moving into a higher tax bracket, potentially reducing taxes on Social Security benefits and keeping Medicare premiums from rising.
Inherited IRA QCD Rules
When making a qualified charitable distribution (QCD) from an inherited IRA, there are specific rules that need to be followed to make the process both compliant and beneficial. By understanding these guidelines, you can maximize the potential advantages while staying within the IRS regulations. Here’s a list of rules you must follow:
- Can be made as long as the current owner is 70 ½ or older: To qualify for a QCD, the person inheriting the IRA must be 70½ or older. If distributions are made before reaching this age, they will not qualify as QCDs and instead be treated as regular taxable income.
- Charitable contributions must be made to a qualified 501(c)(3) organization: For a QCD to be valid, the donation must go to a qualified charity recognized under section 501(c)(3) of the Internal Revenue Code. Not all organizations qualify, so it’s important to confirm the charity’s status before making a contribution. Contributions to donor-advised funds, supporting organizations, and private foundations are excluded from eligibility.
- Maximum annual QCD amount for 2024 indexed at $105,000 per person: The maximum amount that can be donated through QCDs in 2024 is $105,000 per person. This cap applies to all QCDs made during the year, regardless of the number of charities receiving the donations. Keep in mind that this limit is subject to adjustment in future years.
Please Note: You can also opt for a one-time split election. According to Section 307 of the Secure Act 2.0, in 2024, donors are allowed to make a Qualified Charitable Distribution (QCD) of up to $53,000 to a split-interest entity, marking an increase from the previous $50,000 limit in 2023. This QCD can be directed toward a Charitable Remainder Unitrust (CRUT). It can also go to a Charitable Remainder Annuity Trust (CRAT) or Charitable Gift Annuity (CGA). This election is a lifetime opportunity and should be planned strategically to maximize its advantages.2
Other Considerations
If you decide to take your required minimum distribution (RMD) as regular income, it will add to your taxable income for that year. This increase might result in a higher tax liability and could even move you into a more expensive tax bracket. However, by opting for a qualified charitable distribution QCD, you can fulfill your RMD requirements without raising your taxable income, which could help you manage your taxes more effectively.
Moreover, Medicare premiums are significantly influenced by your income level. A higher income can trigger increased premiums due to the Income-Related Monthly Adjustment Amount (IRMAA). Utilizing a QCD to meet your RMD can help keep your gross income lower, which may allow you to avoid higher Medicare premiums and potential IRMAA penalties.
Special Situations to Know About
Certain special cases, like when minor grandchildren inherit IRAs, call for careful consideration due to the specific rules involved. These situations can be complex, so it’s important to understand the implications for proper planning.
Spousal Inheritance of IRAs
When a spouse inherits an IRA, they have several paths to consider, influenced by whether or not the deceased had reached the Required Minimum Distribution (RMD) age at the time of passing.
Before RMD Age: If the spouse who passed away had not yet reached the RMD age, the surviving spouse has a couple of choices. They can transfer the IRA into their own account, treating it as though it were always theirs, or they can establish an Inherited IRA and follow the life expectancy method. This approach allows the funds to continue growing with tax-deferred advantages.
After RMD Age: If the deceased spouse had already started taking RMDs, the surviving spouse is required to continue taking RMDs. The distributions may be calculated either according to the life expectancy of the survivor or the remaining life span of the deceased. Taking a lump sum distribution is another option, but this could result in significant tax implications.
Non-Spousal Inheritance of IRAs
The rules become more stringent for non-spousal beneficiaries. Typically, beneficiaries that are non-spousal cannot treat an inherited IRA like it’s their own. Instead, they must choose from the following options:
Use the Life Expectancy Method: This option is reserved for Eligible Designated Beneficiaries (EDBs), such as minor children, those who are chronically sick, or beneficiaries who are no more than ten years younger than the deceased. This method allows for RMDs based on life expectancy until the minor reaches the age of 21, after which the 10-year rule comes into effect.
Adhere to the 10-Year Rule: Most non-spousal beneficiaries, unless they qualify as EDBs, are required to fully withdraw the assets in the IRA within ten years. During this period, RMDs are not mandatory, but the account must be entirely depleted by the end of the tenth year.
Lump Sum Distributions
Regardless of their relationship to the decedent, any beneficiary has the option to receive a lump sum distribution from the IRA they inherited. Choosing this option typically results in the entire sum being taxed as income in the year it is withdrawn, which could push the beneficiary into a higher tax bracket. While this might be suitable in some situations, it frequently results in a significant tax burden.
Steps to Make a QCD from an Inherited IRA
If you’re looking to make a qualified charitable distribution QCD from an inherited IRA, it’s important to follow the correct steps to meet IRS requirements and gain the full tax benefits. Let’s walk through the basic steps to get you started:
- Inform your IRA custodian: Begin by letting your custodian know you intend to make a charitable distribution directly from your inherited IRA.
- Transfer funds directly to the charity: It’s essential that the money goes straight to the qualified charity without being handled by you, ensuring it qualifies as a QCD.
- Complete the transfer before December 31st: To have the QCD count for the current year’s required minimum distribution RMD, make sure the funds are transferred by the end of the tax year.
- Confirm with your custodian: Double-check with your custodian that the transfer was successful and that the charity received the funds.
Documentation and record-keeping requirements
Keeping proper records when making a QCD is crucial for both filing your taxes and ensuring the IRS acknowledges the distribution as tax-free. Understanding what’s required and maintaining accurate records will make the process smoother. Here’s what to do:
- Obtain a confirmation from the charity: After completing the QCD, request a receipt or letter from the charity that confirms the donation amount and states no goods or services were exchanged.
- Keep your records secure: Store this confirmation safely, as it will be necessary when filing your tax return to prove the QCD and secure its tax benefits.
- Report the QCD on your tax return: Even though the QCD is not included in your taxable income, it must still be reported on IRS Form 1099-R as a non-taxable distribution. This step is important to avoid any issues with your taxes. Consulting a tax professional can help ensure the QCD is reported correctly, maximizing your tax savings.
Common Mistakes to Avoid
Being aware of these pitfalls can help you avoid issues and ensure that your QCD is handled correctly. Here are some frequent errors to watch out for:
- Missing the age requirement: One of the most common mistakes is trying to make a QCD before reaching the age of 70½. If the IRA beneficiary is under this age, any distribution will not qualify as a QCD and will instead be subject to regular income taxes, which could lead to an unexpected tax bill.
- Not confirming the charity’s 501(c)(3) status: Another mistake is failing to verify that the charity you want to support qualifies under 501(c)(3) rules. If the organization doesn’t meet this IRS criterion, your donation won’t be considered a QCD, and you’ll be liable for taxes on the distribution.
- Ignoring the impact on RMDs and potential tax consequences: Some people mistakenly think that any QCD amount will automatically satisfy their required minimum distribution RMD for the year. It’s crucial to ensure that the QCD covers the full RMD amount to avoid additional taxes. Also, not considering how the QCD affects your taxable income might lead to other financial consequences, like increased Medicare premiums or higher taxes on Social Security benefits.
Please Note: If you’re unsure about whether or not your charitable organization meets IRS requirements, you can use the Tax Exemption Organization Search tool on the Internal Revenue Service’s official website.3
Let Us Help You
Leveraging a qualified charitable distribution QCD from an inherited IRA is a powerful way to align your financial and charitable objectives. By adhering to the necessary requirements—such as confirming your eligibility and making sure the donation goes straight to a qualified charity—you can fully benefit from the tax advantages that QCDs offer. This approach not only helps you meet your required minimum distribution RMD needs but also gives you more control over your taxable income, potentially reducing your tax liability.
If you’re exploring how to integrate QCDs from inherited IRAs into your overall financial strategy, we are here to assist. We offer personalized advice designed to help you get the most out of this strategy.
Financial Success Doesn’t Happen by Chance.
Schedule an appointment today to learn how we can tailor this approach to fit your specific needs and help you reach your financial and charitable goals: 940-464-4104 or https://RFGWealthAdvisory.com.
RFG Wealth Advisory is an independent, fee-only Registered Investment Advisor firm in Argyle, Texas. At RFG Wealth, our fiduciary duty ensures that your interests always come first, and we maintain a transparent fee structure for your peace of mind. Contact us today!
Investment advice is offered through RFG Wealth Advisory, a Registered Investment Advisor.
Resources:
- https://www.schwab.com/learn/story/reducing-rmds-with-qcds
- https://www.fidelitycharitable.org/articles/secure-act-2-0-retirement-provisions.html
- https://apps.irs.gov/app/eos/
