Q: I turned 73 this year and I know that I am able to donate money to charities right from my IRA. Since I now have to take required distributions, I’m wondering if there is an optimal amount I should be donating in terms of tax planning. How should I think about this?
A: Before answering your question, let’s first talk about the concept of charitable intent. If you need or want your IRA money for yourself, paying taxes is a perfectly okay thing to do. In other words, tax planning alone shouldn’t drive your decision to donate money that you need or want.
But if you do want to donate money, then a “Qualified Charitable Distribution” from your IRA – also known as a QCD – is a really tax-smart way to give it away.
As you know, once you reach 70½, you can start to donate money from your IRA to qualified charities. Then, in the year you turn 73, you’ve got required minimum distributions – or RMDs – to satisfy. The good thing is your IRA donations can count toward your annual RMD amount. And, your IRA donations are excluded from your taxable income. Remember, your IRA donations are funded with tax-deferred money that will never get taxed if it’s given to a charity.
Now that I’ve covered the basics of QCDs, let’s move onto your main question of how much you should give away from a tax planning perspective.
First, the most obvious thing to consider is your marginal federal tax bracket. If a larger QCD keeps your taxable income from spilling into a higher tax bracket, that’s definitely a good thing. But, frankly, with tax brackets being so big and with marginal tax rates so flat nowadays, it might take some large donations to make a real difference.
Second, watch out for the Medicare IRMAA thresholds. These income-related surcharges increase your Medicare premiums once your income crosses certain levels. Since a QCD reduces your income, a carefully-sized donation might help to keep you below one of those Medicare IRMAA thresholds. In some cases, this type of analysis can be more valuable than tax bracket management.
Third, higher-income retirees should also keep an eye on the 3.8% Net Investment Income tax. While your IRA distributions are not considered investment income, lowering your income through QCDs can affect whether this special add-on tax will hit you or not.
Finally, the new $6,000 senior deduction for those who are at least age 65 is another thing to consider. This new deduction – it started last year – phases out as your income rises. Again, because QCDs work to lower your income, they may also help you preserve some or all of the senior deduction.
So, the optimal IRA donation is all about understanding the tax code as well as the size and sources of your income. First start with the amount you genuinely want to give away. Then, work with your tax professional or investment advisor to test out different IRA donation amounts to see their full impact. You might find it interesting (and frustrating) to see just how complex the tax code really is!
