What’s the Most Tax-Efficient Way to Give? (Donating Appreciated Securities, Qualified Charitable Distributions)

A reader writes in, asking:

“I will be turning 70 1/2 next year and one way or another I plan on giving a good sum to charity. What is the most economical way to donate?

1. QCD from IRA
2. Roth IRA
3. Taxable account
4. Take from income.

I take the standard deduction for federal tax. What factors do I need to take into consideration?”

Firstly: What’s a QCD?

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 they can be used to satisfy required minimum distributions (RMDs) for a given year. QCDs are limited to $100,000/year (per spouse, if you’re married).

To qualify for qualified charitable distributions you must be at least age 70.5. (Yes, it really is age 70.5. The law that increased the age for RMDs to 72 did not change the age for QCDs.)

Also note that QCDs work on a calendar year basis. That is, there’s no “I’m doing this in March of 2022, and I want it to count for 2021” option as there is for contributions to an IRA.

Which Type of IRA to Give From

Giving via QCDs from a traditional IRA is much better than donating dollars from a Roth IRA. To you, a dollar in a Roth IRA is worth a dollar of spending, whereas a dollar in a traditional IRA is worth less than a dollar of spending (because some part of the dollar would be taxed when you took it out of the account, before you could spend it).

In contrast, to a tax-exempt non-profit, a dollar from a traditional IRA is worth a dollar of spending. When you give money to a charity via a QCD from a traditional IRA, the charity doesn’t have to pay tax on that money.

In other words, from the charity’s perspective, receiving $1,000 from a traditional IRA (via a QCD) is just as good as receiving $1,000 from a Roth IRA. But giving the money from the traditional IRA effectively costs you less (because it wasn’t really worth $1,000 to you to begin with).

Donating via QCDs or Taxable Assets

When choosing between QCDs or donating taxable assets, one advantage of QCDs is that you can take advantage of them while claiming the standard deduction. Donations from taxable assets (including regular checking account dollars) give you an itemized deduction. And that’s only valuable to the extent that your itemized deductions (in total) exceed the standard deduction for the year.

Example: Sophia is single, age 65+, so her standard deduction for 2021 is $14,250. If her itemized deductions other than donations come to $10,000, then the first $4,250 of donations from taxable assets doesn’t give her any tax benefit at all.

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/credit or bringing your income below a particular IRMAA threshold. In contrast, the itemized deduction from donating taxable assets does not reduce your AGI and therefore will not produce any such effects.

Conversely, an advantage of donating assets from a taxable account is that, if you donate assets 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. (Note: when donating taxable property that you have held for one year or less, your itemized deduction is limited to your basis in the property.) In other words, when donating appreciated taxable assets that you have held for longer than one year, the itemized deduction is saving you money at your marginal tax rate for ordinary income, and you’re saving some additional money due to not having to pay tax on the appreciation.

So in some cases donating via QCDs will be preferable, while in other cases donating appreciated securities will be preferable. An important factor here is how much the taxable asset has appreciated. If it has gone up, say, 10% since you bought it, then getting to avoid taxation on the 10% gain isn’t such a big deal. Conversely if it is now worth ten times what you paid for it, avoiding taxation on that gain — via donating the asset — could be a very big deal. (I say “could” in that prior sentence, because there’s a possibility that the gain could have avoided taxation anyway, if it were left to heirs who would then get a step-up in cost basis.)

Which Taxable Assets to Give?

And 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). And again that’s because you do not have to pay tax on the appreciation, while still getting to claim an itemized deduction for the current market value of the assets.

For example, imagine that you have a holding with a $10,000 market value and a $6,000 cost basis (i.e., there is a $4,000 unrealized capital gain) and you have held the asset for longer than one year. If you donate this asset, you’d get an itemized deduction for $10,000. Conversely, if you were to donate $10,000 of cash, you would also get an itemized deduction for $10,000. But donating $10,000 of cash means giving up $10,000 of spendable value, whereas donating the $10,000 appreciated holding actually costs you somewhat less (because if you were to sell it, you’d have to pay tax on the $4,000 of appreciation, which would leave you with somewhat less than $10,000 to spend).

Overall Order of Priority

To briefly summarize, for somebody age 70.5 or older, the typical order of preference is:

1. Donating appreciated taxable assets with a holding period longer than one year or donating via QCDs, depending on circumstances,
2. Donating via whichever of the two options above was less preferable,
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, and finally
6. Donating taxable assets where the current market value is less than your basis. (This one is really bad 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.)

For somebody not yet age 70.5 (and therefore ineligible for QCDs), the typical order of preference would be:

1. Donating appreciated taxable assets with a holding period longer than one year,
2. Donating taxable account cash (e.g., checking/savings balances),
3. Donating appreciated taxable assets that you have held for one year or less,
4. Donating Roth IRA or traditional IRA dollars, and finally
5. Donating taxable assets where the current market value is less than your basis.

But as always, tax planning is case-by-case. A household could have circumstances such that the above would need to be rearranged in some way.