Qualified Charitable Distributions (QCDs): How do they work, and are they the best option for charitable giving?

The following is an excerpt from my book More Than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need.

A qualified charitable distribution (QCD) is a distribution from a traditional IRA directly to a charitable organization (i.e., the check is made out directly to the organization rather than to you). Unlike most distributions from a traditional IRA, QCDs are not taxable as income. And QCDs count toward your required minimum distribution for the year in which you take the QCD. QCDs are limited to $100,000/year — per spouse, if you’re married. (Beginning in 2024, this $100,000 limit will receive annual inflation adjustments.)

To qualify for qualified charitable distributions you must be at least age 70.5. (Yes, it really is age 70.5. The legislation that increased the age for RMDs did not change the age for QCDs.)

Qualified charitable distributions work on a calendar year basis. That is, there’s no “I’m doing this in March of 2024, and I want it to count for 2023” option as there is for contributions to an IRA.

Another important point about qualified charitable distributions is that they cannot be taken from an employer-sponsored plan such as a 401(k) or 403(b). They must come specifically from traditional IRAs. (This can be a point in favor of rolling assets from an employer-sponsored plan to a traditional IRA.)

Qualified charitable distributions are generally more tax-efficient than taking a normal distri­bution, having it included in your taxable income, and then donating the money. In that second case (taking a taxable distribution, then donating the money), you get an itemized deduction. With a QCD, the donated amount is completely excluded from income which means you can still use the standard deduction in the year in question and still receive a tax benefit from your charitable giving. It also means that your adjusted gross income (AGI) is lower, which can result in other tax savings, because various other deductions and credits are based on your level of AGI.

One final note about QCD rules: a donor-advised fund cannot be the recipient of a qualified charitable distribution.

QCDs vs. Donating Appreciated Taxable Assets

When you donate taxable assets (i.e., assets that are not in any account with special tax treatment such as an IRA) that have gone up in value and that you have owned for longer than one year, you get to claim an itemized deduction for the current market value of the asset and you do not have to pay tax on the appreciation.

EXAMPLE: Carmen owns shares of stock that she purchased 18 months ago for a total of $19,000. The shares are currently worth $25,000. If she donates them, she will receive an itemized deduction for their fair market value ($25,000).

In other words, when donating appreciated taxable assets that you have held for longer than one year, there are two potential sources of tax savings. Firstly, you get an itemized deduction for the donation. And secondly, you do not have to pay tax on the appreciation.

When choosing between qualified charitable distributions or donating taxable assets, one advantage of QCDs is that you can take advantage of them while claiming the standard deduction. In contrast, donations from taxable assets (including regular checking account dollars) give you an itemized deduction. And itemized deductions are only valuable to the extent that they (in total) exceed the standard deduction for the year.

QCDs also have the advantage that they reduce your adjusted gross income, which can sometimes produce additional beneficial results, such as allowing you to qualify for another deduction or credit or bringing your income below a particular threshold for determining Medicare premiums. In contrast, the itemized deduction from donating taxable assets does not reduce your AGI and therefore will not produce any such effects.

With regard to donating taxable assets, donating appreciated assets that you have owned for longer than one year is strictly better than donating other taxable account dollars (e.g., cash in a checking account), because you get to claim an itemized deduction for the current market value of the assets, while not having to pay tax on the appreciation.

To briefly summarize, the typical order of preference for donations each year is:

1. Donating via QCDs (if you’re at least age 70.5),
2. Donating appreciated taxable assets with a holding period longer than one year,
3. Donating taxable account cash (e.g., checking/savings balances),
4. Donating appreciated taxable assets that you have held for one year or less,
5. Donating Roth IRA dollars (or donating traditional IRA dollars if you are younger than 70.5), and finally
6. Donating taxable assets where the current market value is less than your cost basis. (This option is unwise because your deduction is limited to the market value, and you don’t get to claim a loss for the decline in value. Better to sell the asset, claim the capital loss, then donate the resulting cash.)

Simple Summary

• A qualified charitable distribution is a distribution from a traditional IRA directly to a charitable organization (other than a donor-advised fund).
• QCDs are excluded from your gross income, but they still count toward your required minimum distribution for the year in which you take the QCD.
• QCDs are limited to $100,000 per year (per spouse, if you’re married). This $100,000 limit is scheduled to start receiving annual inflation adjustments beginning in 2024.
• You must be at least age 70.5 in order to take a qualified charitable distribution.
• For people with charitable intentions who don’t intend to spend their entire RMD in a given year and who are concerned about the tax bill they’ll face on their RMDs, qualified charitable distributions are an excellent solution. The overall result is that you were able to claim a deduction when you put the money into the account, the money grew tax-free over time while it remained in the account, and now it comes out tax-free as well.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.