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Retirement Perspectives

Given that the new tax law eliminates many itemized deductions, qualified charitable distributions (QCDs) can serve as a worthy tax-planning strategy.

The use of qualified charitable distributions (QCDs) is poised to increase thanks to the Tax Cut and Jobs Act (TCJA). QCDs were first made available in 2006 as part of the Pension Protection Act. Although QCDs were popular, they were not made permanent by Congress until 2015 as part of the Protecting Americans from Tax Hikes Act. A QCD is the distribution of up to $100,000 annually from an IRA by an account owner aged 70½ or older directly to an eligible charity. The TCJA nearly doubled the standard deduction, while eliminating many itemized deductions, making tax season the ideal time to review the numerous valuable benefits offered by the QCD strategy.

A charitable contribution is itself an itemized deduction, so most taxpayers will no longer receive the full deduction value—unless all other itemized deductions exceed the standard deduction amount. In addition, a charitable deduction is not available when using the new increased standard deduction. However, a taxpayer can utilize the standard deduction and QCD strategy in the same tax year. In other words, fewer taxpayers will itemize, thus fewer taxpayers will be able to take advantage of the deduction for charitable giving. If, due to the new tax regime, the value of a charitable contribution does not offer the same value as in prior tax years, consider other options, such as a QCD.

What does an individual who made a QCD in 2018 need to know?
Some but not all retirement account’s allow a taxpayer to make a prior year (2018) transaction. For example, an individual can make a 2018 IRA contribution through April 15, 2019. In addition, a business owner on extension can fund his or her SEP IRA through October 15, 2019. However, for taxpayers looking to make a QCD for 2018—that window closed on December 31, 2018. In other words, you are never allowed to make a prior year QCD. Instead, QCDs must be taken in the calendar in which the taxpayer plans on reporting it.

For those individuals who made a 2018 QCD, it’s vital the transaction is communicated to the tax professional. Why? QCD is not specifically reported on Form 1099-R. There is no specific or special code to report a QCD. Without proper communication, the tax preparer will most likely report the QCD as any other IRA distribution and thus include the amount as taxable income.

For 2018 tax reporting, there will be a way to record QCD on the new, revised Form 1040. The IRA owner can report the full amount on line 4a for IRA distributions; on line 4b for the taxable amount, enter zero if the full amount was a QCD with “QCD” written next to it on the 1040 form, according to tax expert Ed Slott.

What does an individual need to know before making a QCD in 2019?
To be QCD eligible, an individual must be age 70½ or older. This is different from rules for required minimum distributions (RMDs), where an individual is eligible to take his or her first RMD in the year he/she reaches age 70½. QCD eligibility specifically requires an individual to have already reached age 70½.

QCDs require advanced planning precisely for those individuals that prefer to take their RMD earlier in the year. Why? Because of the “first dollars out” rule; here, the first dollars distributed from an IRA during the year count toward satisfying the annual RMD.

Example:  “First dollars out”
Max, 78, likes to take his RMD early in the year. On February 1, as is his custom, he takes an IRA distribution of $50,000, representing his 2019 RMD. Later in 2019, Max decides after meeting with his new advisor that he would like to make a QCD. Unfortunately, Max cannot retroactively reclassify his previous February distribution as a QCD. Instead, his distribution is reported as an RMD and reported as taxable income on Max’s 2019 return. Notably, Max can still do a QCD, but it will not satisfy his RMD.

Therefore, it’s strongly recommended that QCDs be discussed with an advisor (or tax professional) and completed early in the year.

Although QCDs have been around for a number of years, there is a lot of misinformation circulating.  A single innocent mistake can cause a taxpayer to lose QCD eligibility, thus having to report taxable  income—that should have been tax free if the rules were properly followed. To help properly implement the QCD strategy, here is a list of commonly asked questions and answers.

What’s the QCD limit?
An individual 70½ or older can transfer up to $100,000 annually from his or her IRA directly to an eligible charity. For married taxpayers, the QCD limit increases to $200,000, as each spouse can transfer up to $100,000.

Tip: There is no carry forward provision. Each year, the limit is a maximum of $100,000 regardless of whether a QCD was used in a prior year.

How do QCDs affect RMDs?
The QCD can satisfy an RMD for the year, but, again, it is capped at $100,000.

Which retirement plans are eligible for QCD treatment?
QCDs are available from IRAs only. QCDs are not available from employer-sponsored plans (e.g., 401(k), 403(b), 457(b) or TSP). In addition QCDs are not eligible from active SEP and SIMPLE IRAs.

Tip: There is also a special rule for those IRA owners who have accumulated nondeductible (aftertax) dollars. A QCD is deemed to come first from the pretax portion of an individual’s IRA, instead of from pretax and aftertax funds proportionately. In other words, QCDs are not subject to pro-rata distributions rules.

How does an individual donate QCD assets?
Payment must be sent directly to a public charity via a trustee transfer. Notably, the proceeds can be mailed directly to an IRA owner—as long as the check is made payable to the qualifying charity. If the check is made out to the IRA owner, the donation would not qualify as a QCD.

Additional QCD rules to consider are:

  • QCDs are not included in taxable income.
  • QCDs do not qualify for a charitable deduction. However QCDs satisfy RMDs without increasing adjusted gross income, thus lowering or eliminating Social Security benefit taxation, Medicare premiums, alternative minimum tax, 3.8% investment surtax and medical expense deductions, or being bumped to a higher marginal tax bracket.
  • QCDs can be taken from an inherited IRA. However, the beneficiary must be 70½ or older.
  • Roth IRAs, although QCD-eligible, generally aren’t appropriate. Roth IRAs have no lifetime RMDs; in addition, only taxable funds can be used for QCDs. A majority of Roth distributions will be tax free—there’s no (tax) benefit to donating previously taxed funds.
  • Donor-advised funds and private foundations do not qualify for QCD treatment. Instead, the proceeds must be sent to a public 501(c)(3) charity.
  • Discuss QCD processing and required paperwork with your IRA custodian.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

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