Why Required Minimum Distributions (RMDs) and Qualified Charitable Distributions (QCDs) Matter to People of All Ages

This is week two of our 7-week series. If you wish to read our article from week one you can read it here.

Introduction

As individuals of all ages approach retirement, navigating the complexities of tax-advantaged accounts becomes increasingly important. Two crucial concepts to understand are Required Minimum Distributions (RMDs) and Qualified Charitable Distributions (QCDs). While these concepts technically only apply to people over the age of 70, they are relevant to everyone planning for retirement because of the way they impact your spendable dollars.

And with $35 trillion of national debt on our books, retirement planning for younger people must incorporate the impact of Required Minimum Distributions on their retirement income.

• The federal government will spend more than $1 trillion in 2025 to cover the interest on our national debt, surpassing national defense and Medicare spending. 

• Our national debt is growing by $1 trillion every 150 days, and neither the Democrats nor Republicans have a plan to fix this problem.  

• As the United States is forced to reissue our maturing debt at the current higher interest rates, our interest cost on the debt will grow even higher than it is today.

That’s why these concepts matter for people of all ages. The United States government must cut spending, raise taxes or deflate the dollar. If the Federal government doesn’t do one or all three of the aforementioned items, the United Sates will be forced to default on its debt. If the United States chooses to raise taxes, this will have a dramatic impact on those who defer taxes through their 401(k) or IRA contributions.

What Are RMDs?

RMDs are the minimum amounts that a retirement account owner must withdraw annually, starting at age 73, from their tax-deferred retirement accounts such as Traditional IRAs, 401(k)s, 403(b)s, and other similar plans. The purpose of RMDs is to ensure that individuals eventually pay taxes on the money they have deferred, as these accounts typically consist of pre-tax contributions and earnings.

When Do RMDs Begin?

As of 2024, RMD’s must be taken by December 31st of each year, once a person turns 73, except for the first RMD, which can be delayed until April 1st of the year following the year. However, delaying the first RMD means taking two distributions in one year, which could push the account holder into a higher tax bracket.

How Are RMDs Calculated?

The RMD calculation is based on the account balance at the end of the previous year and the account holder’s life expectancy, as determined by the IRS. For example, a taxpayer with $1 million dollars in their IRA will be required to distribute about 3.8% of their account value with their first RMD, and this percentage requirement will rise every year, even if they do not need the money.  If an account holder fails to take their RMD, or if they withdraw less than the required amount, they may face a significant tax penalty—50% of the amount that should have been withdrawn. The bottom line: the RMD creates mandatory taxable income, inflating their tax bill when most people are on a fixed income.

Qualified Charitable Distributions (QCDs)

What Are QCDs?

A QCD is a direct transfer of funds from an IRA, payable directly to a qualified charity. For those aged 70½ or older, QCDs offer a tax-efficient way to satisfy all or part of their RMD while simultaneously supporting charitable causes. The maximum annual QCD amount is $100,000 per individual, which can be especially beneficial for those who do not itemize deductions.

How Do QCDs Work?

When a QCD is made, the amount transferred directly to charity is excluded from the account holder’s taxable income. This exclusion can lower the individual’s adjusted gross income (AGI), potentially reducing the impact of other tax provisions tied to AGI, such as Medicare premiums or the taxation of Social Security benefits. Importantly, the QCD can satisfy the account holder’s RMD for the year without increasing their taxable income.

Key Considerations for QCDs

• Eligibility: The account holder must be at least 70½ years old at the time of the distribution.

• Qualified Charities: The distribution must be made to a 501(c)(3) organization that qualifies as a public charity. Private foundations, donor-advised funds, and supporting organizations are not eligible.

• IRA Only: QCDs can only be made from IRAs, not from 401(k)s or other employer-sponsored retirement plans.

• Tax Reporting: QCDs should be reported on the account holder’s tax return, but they are not included in taxable income.

• Tax Planning: It’s mission-critical to have a financial planner who understands your tax situation, as this is easily missed by tax preparers who are not involved in the planning process.

  
  

Strategic Considerations

Combining RMDs and QCDs

For retirees who are charitably inclined, QCDs offer a tax-efficient strategy to meet RMD requirements while reducing their taxable income. By directing RMDs to charity via a QCD, individuals can achieve their philanthropic goals and potentially avoid higher tax liabilities.

Impact on Estate Planning

Both RMDs and QCDs play a role in estate planning. RMDs reduce the balance of tax-deferred accounts, which may lower the taxable estate. QCDs can also be an effective way to transfer wealth to charitable causes without incurring estate taxes.

More Bang for your Buck

When giving with pre-tax dollars through a QCD, your charitable organization receives a larger donation than if you were to first take the RMD into income and then pay taxes on that income.

Conclusion

Understanding RMDs and QCDs is essential for retirees looking to manage their income tax liabilities and charitable giving effectively. By strategically using these tools, individuals can meet their required distributions, potentially lower their taxable income, and support the causes they care about most.

As with all tax and financial planning decisions, consulting with a financial advisor or tax professional is recommended to ensure that these strategies align with personal financial goals and tax situations. How can Monotelo Advisors Help You?

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