I’m not sure if there is an actual definition of success tax, however if I were to locate one, it might state that the Required Minimum Distribution is the definition of success tax. Imagine you have done the hard work of getting out of debt, you execute Baby Step 4 and as Dave Ramsey clearly articulates, you emulate the tortoise not the hare, in that you are diligent over the next 20-30 years of savings. Your retirement is fully funded and you’re ready to enjoy the fruits of your labor and then you turn 72 and the government starts forcing out money, from your pre-tax retirement accounts, such as Traditional IRAs and 401(k)s. This creates a potential tax liability on money you may not need nor want, yet the IRS wants to tax it before your death. How can one eliminate this issue? The Qualified Charitable Distribution.

Required Minimum Distributions

First let’s define what a required minimum distribution is. When you have pre-tax or Traditional IRA’s, this money has never been taxed because it was taken out of your paycheck before taxes were withheld. Additionally, all your employer match, is typically pre-tax therefore that money will be subject to a required minimum distribution. All your pre-tax money is required to be taken out starting at age 72 (this was changed from 70.5 when the SECURE ACT of 2019 was passed) and every year you’re alive afterward based on IRS formulas. You can check out your estimated required minimum distributions by using this calculator. Finally, if you don’t take your RMD, you’ll have to pay a 50% penalty to the IRS on whatever distributions you were supposed to take but didn’t.

Be Proactive Younger – Roth IRA’s

Before we dive into qualified charitable distributions, it’s prudent to understand with the help of your financial advisor and the financial plan they can help you create, if you should be doing Roth IRA’s at a younger age, even if your tax rate is higher, to avoid these pesky required minimum distributions. Roth IRA’s, because all the contributions have been taxed and the growth won’t be taxed, as long as they are distributed after retirement (59.5), have no required minimum distributions. Let me say that again, Roth IRA’s have no required minimum distributions. Thus, the tax savings of not being forced into higher tax brackets at 72 and older, is typically enough to justify them alone, outside of the tax-free growth and tax-free distributions. Recently, I did write an article that discussed how someone very close to retirement should consider pre-tax and then Roth conversions, right after they retire and presumably fall into a lower bracket. Read that article here.

Qualified Charitable Distribution (QCD)

Qualified Charitable Distributions are a way for you to give your Required Minimum Distribution to the charity of your choice and avoid paying income tax on the distribution, counting it towards your RMD and avoiding the 50% penalty for not taking the RMD. To qualify for the QCD, you need to be at least 70.5 years old, the IRA custodian (Charles Schwab in our case) needs to transfer the funds directly to the charity and the charity must be approved by the IRS. Eligible charities include 501(c)(3) organizations and houses of worship. Donor-advised funds are not permitted to receive QCD’s. The IRS provides you with a database to search approved charities here.

Qualified Charitable Distribution Example

Let’s set the table for how someone might use the QCD in retirement. Johnny Client and Suzie Client have approx. $400,000 in their pre-tax retirement Traditional IRA. The RMD on this account in 2022 is $20,000. Their income is broken out as follows

• $24,000 – Johnny Social Security

• $20,000 – Suzie Social Security

• $40,000 – Roth IRA Distributions

$84,000 Total Income – of which $44,000 is taxable (Roth IRA distributions are not taxed). Social Security only gets a partial taxation and the threshold is income between $32,000 - $44,000 (if married filing jointly) makes 50% of your benefit taxable and anything more than $44,000 makes 85% of your benefit taxable. Meaning this $20,000 RMD is going to make 35% more of their SSI taxable unless they use QCD’s.

Therefore, in this case if we take the RMD and give $5,000 to the local pregnancy center, $1,600 to the local humane society and $5,000 to the local children’s home, serving kids in the foster care system and $8,400 as their normal tithe to their church, they have been able to give the entire $20,000 to causes and institutions they care most about. In comparison, if they took the RMD and gave the money to those charities because they’d be paying income tax (federal and state) they have approx. 15% less to give.

Additionally, we improved their cash flow. Instead of giving their $8,400 tithe to their church through their income, we were able to give it through their QCD, therefore saving them tax dollars and we put $700 back into their monthly budget because normally that $700 would have come from their Social Security and Roth IRA Distributions.

Finally, by keeping their reportable income below $44,000 we kept 35% of Social Security from being taxable (about $15,400 worth of income) which may have saved them approx. $2,000 in state and federal income taxes, therefore further improving their monthly cash flow (around $166 / month).

The total estimated savings for this client was incredible. $2,000 by not taking the RMD and making it a QCD instead. $2,000 by not increasing their amount of their SSI that is taxable and $8,400 back into their cash flow by allowing their QCD’s to create their tithe, as opposed to their normal cash flow. Johnny & Suzie saw a $12,400 improvement in their cash flow. Your savings may be this great, but the QCD is surely still a conversation worth having with your SmartVestor Pro.

Conclusion

There are many rules around the QCD’s and you certainly would be well positioned to navigate those rules, in light of your particular situation, with a SmartVestor Pro and Tax ELP on your team. We would be happy to help you consider the benefits of a QCD, by reaching out to us today.