WHAT ARE QUALIFIED CHARITABLE DISTRIBUTIONS (QCD’S)?
A Qualified Charitable Distribution (QCD) is an otherwise taxable distribution from an IRA owned by an individual who is age 70½ or older and paid directly from the IRA to a qualified charity.1
QCDs count toward your Required Minimum Distribution (RMD) and will reduce taxable income up to $100,000 per individual. Reducing taxable income can help minimize the taxation of social security income and Medicare premiums. For example, up to 85% of social security income for joint filers is taxable whose Modified Adjusted Gross Income (MAGI) is more than $44,000. QCDs lower MAGI and could potentially decrease or eliminate this tax. The standard monthly Medicare Part B premiums begin at $170.10/month per person for joint filers whose MAGI is less than $182,000. MAGI exceeding $182,000 begin to increase monthly Medicare premiums and there are six income thresholds that increase up to $578.30/month per person.
Often, a QCD provides greater tax savings than cash donations because the QCD reduces your Adjusted Gross Income. If cash contributions are less than the standard deduction preventing itemized deductions, a QCD still allows individuals to receive a tax benefit.
Refer to the case study comparing a cash gift vs. Qualified Charitable Distribution gift:
What is a Roth IRA Conversion and the Benefits?
A Roth IRA conversion occurs when you move funds from an IRA into a Roth IRA. Because taxes are due upon conversion, there are questions that you want to ask yourself before implementing this strategy.
- Does it make sense for you to pay taxes now or later?
- Are you dependent on your IRA to provide income in retirement?
- Who are the beneficiaries of your IRA?
Taxes Now or Later
Converting an IRA to a Roth IRA can be advantageous if you anticipate that your tax rates will increase in the future. Determining what your tax bracket is now vs. in the future is the key consideration. Tax efficient conversions can potentially prevent you from ending up in a higher marginal tax bracket in the future. One of the main culprits causing an increased future tax burden occurs when Required Minimum Distributions (RMD) begin at age 72. Although taxes are immediately due on the amount converted, by removing the assets and their growth from a taxable IRA into a tax-free Roth IRA, one can potentially save considerable money in taxes over the long term. Also, a conversion now can help maintain a lower income threshold for Medicare premiums in the future. Another benefit is that RMDs do not apply to Roth IRAs. Therefore, allowing the conversion amount to grow tax-free indefinitely or until you take withdrawals. Roth conversions are even more productive in years of market decline as a recovery on investment value would happen in a tax-free account.
Income Needs in Retirement
Roth conversions may not be suitable if you are close to retirement and will need your IRA money for living expenses. Because taxes are due immediately upon conversion, it takes time for the benefits of tax-free growth in a Roth IRA to outweigh the current tax consequences. Also, Roth IRAs have a 5-year holding period rule to receive tax free distributions. If you take a distribution from a Roth IRA prematurely taxes and penalties can be assessed.
A Roth IRA is a more tax efficient asset to pass on to your heirs. Due to the Secure Act passed in 2020, all inherited IRAs require full distribution within a 10-year period for non-spouse beneficiaries. Distributions from an IRA are taxed as ordinary income. Distributions from a Roth IRA are tax-free. If, however you plan to leave your IRAs to a charity, a conversion is not prudent. Charities are typically exempt from paying taxes. By doing a conversion and paying taxes now, you are leaving less to the charity in the future.
As clients of Fragasso, these tax efficient strategies may have been implemented within your unique planning. Whether you are considering a Qualified Charitable Distribution or a Roth conversion, your financial advisor at Fragasso can help analyze and collaborate with you and your professional tax advisor to determine the best course of action.