We’ve discussed the possible ramifications of forced income and the tradeoffs when it comes to large balances in retirement accounts. One of the consequences is large Required Minimum Distributions (RMDs).
What are RMDs?
RMDs are the amounts that are required to be distributed from qualified retirement plans (employer-sponsored plans such as 401k or 403b plan) and Traditional IRA accounts each year. Regular Roth IRAs and Roth 401ks are not subject to RMDS, but inherited Roth accounts are subject to these required distributions.
Generally, RMDs begin when you have reached a specified age. The RMD age is currently 73 years old, but the required age will increase to 75 years old in 2033. However, those who have inherited IRAs are also often subject to RMDs regardless of their age (except minors). The amount of the RMD is calculated annually and is dependent upon your age (or potentially the age of the decedent in the case of an inherited IRA) and the balance in the account. Quite often, the account owner does not want or need the distribution. And the implications of the additional income can be significant.
For most people, the majority of their RMD will be taxable. In some cases, a portion of the RMD may escape taxes in the current year if you’ve already paid taxes on the contribution to the account in a prior year, but this is uncommon. And, another exception is that RMDs from inherited Roth IRAs are generally not taxable.
Complications can arise from this additional income not only with respect to increasing your income taxes in the current year, but also regarding the amount that you pay for Medicare. It can also cause a loss of benefits that are dependent on your income level. Essentially, the RMD is forced income. Read our article about ways to handle forced income.
Help for charitably-minded taxpayers
As the tax code stands today (January 2025), you are able to deduct qualified charitable contributions when determining your taxable income. However, this deduction only applies if you itemize deductions. Yet, in 2020, only 10% of households itemized deductions, so very few households could take advantage of this deduction.
For many taxpayers who are subject to Required Minimum Distributions, Qualified Charitable Contributions (QCD) are a way to support a favorite charitable organization while also managing their taxable income. In addition to managing income taxes, a QCD can also help reduce your IRMAA (Income-Related Medicare Adjustment Amount).
What is a QCD?
A QCD is a distribution directly from your Traditional IRA account to a charitable organization. A QCD allows IRA owners aged 70½ or older to donate up to $108,000* per year directly from their IRA to a qualified charity. QCDs count toward the RMD and are excluded from taxable income. There are a number of requirements that must be met to ensure that the charitable donation counts as qualified. Here are some of those requirements:
- The IRA owner must be at least 70 ½ years old to qualify. This means that many beneficiaries of inherited IRAs cannot use this strategy because they simply don’t meet the age requirement.
- The distribution must go directly to the charity. The distribution needs to be made directly to the charity from an IRA. QCDs are not available from employer plans. A check will need to be made out to the charity – not to you.
- The maximum annual QCD amount for 2025 is $108,000, and this amount is indexed for inflation.
- The QCD must be the first distribution taken during the year. If you take a distribution and then make a charitable donation, your donation will likely only be deductible if you itemize deductions on your tax return – and few people itemize.
- The distribution must be completed during the calendar year. This means that the charity must actually cash the check so that the funds are out of your IRA account before the end of the year. Therefore, it’s important not to wait until the last few weeks of the year to start the process. You will also need an acknowledgement from the charity of your contribution.
Benefits of a QCD strategy
- Reduce your taxable income which, in turn, reduces your federal and potentially state income taxes.
- May result in a reduced or eliminated IRMAA when compared to taking a taxable IRA distribution and then donating to charity.
- Allows you to support a favorite charitable cause in a tax-efficient manner.
Effect on Medicare premiums
IRMAA, the Income-Related Medicare Adjustment Amount, is an amount that is added to your Medicare Part B and Part D premiums if your income exceeds certain thresholds. There are six IRMAA brackets. Quite often, an RMD which may be unneeded but required, can force a taxpayer into the IRMAA brackets or force them higher in the IRMAA brackets. Read more about IRMAA in our article here.
In many cases, these same people who were forced to take distributions from their retirement accounts also make charitable donations to their favorite charitable organizations. A QCD can allow them to use up to $108,000 (in 2025) of their RMD amount to donate to a qualifying charitable organization. If all the conditions for a Qualified Charitable Distribution are met, the distribution from their IRA will not count as income that can affect Medicare premiums, tax brackets and income-based eligibility for other benefits.
Income tax and IRMAA rules are different
On the other hand, if the taxpayer above took a distribution from their IRA account to satisfy the minimum distribution rules and then made a separate charitable contribution, the outcome could be significantly different. As a hypothetical example, let’s say a Married Filing Jointly couple was content with their $260,000 adjusted gross income in the year before they reached RMD age. Given their retirement account balances, their first RMD will be $75,000 in total. This will increase their adjusted gross income by $75,000. If they then donate the $75,000 to charity, given the dollar amount of the donation, they will likely itemize their deductions and be able to deduct the contribution for income tax purposes. The deduction will reduce their taxable income. Keep in mind that a smaller amount may mean that they likely would not itemize or be able to deduct the charitable donation.
Differently than income taxes, IRMAA surcharges are based on Adjusted Gross Income, not taxable income. This means that the deduction will help reduce income taxes but not the IRMAA surcharge. So, rather than each paying an additional $87.70 in IRMAA surcharges each month at the $260,000 level of income, they will now each pay $352.90 per month in IRMAA surcharges. Even though they donated the funds they withdrew as an RMD, they will be impacted by the increased IRMAA surcharge. They will also be subject to the Net Investment Income Tax on more of their investment income. A QCD would avoid both increased income taxes – regardless of whether they itemize deductions – and the increased IRMAA surcharge.
KEY TAKEAWAY
When considering the federal and state income tax savings in conjunction with the IRMAA savings, the QCD strategy can be quite valuable to someone who is already planning to make charitable donations. However, it takes planning to ensure that you meet all of the requirements.
Don’t think you’ll have this challenge?
Before you assume that you would never be in this situation because your retirement account would simply not be of the size to cause this problem, be sure that you are accurately calculating the effect of compound returns in your retirement account. Consider a $1 million 401k account at age 60 which gets a 7% return every year until age 75 when RMDs will start. There are no additional contributions or withdrawals during that time. That first RMD will be more than $100,000 for just one person. A married couple of the same ages with similar size accounts will have double the RMDs.
This article is intended to be educational and thought-provoking rather than financial, legal or tax advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. During our financial planning process, we examine these factors and many others to determine appropriate financial strategies for YOU.