Understanding RMDs and QCDs
In this episode of Friends Talk Financial Planning, Bridget and I break down the differences between required minimum distribution (RMD) and qualified charitable distributions (QCD). We unravel the connection between these two concepts and provide insight into the impact of each on taxes and charitable giving in later life.
TRANSCRIPT:
John: We recently did an episode that talked about the battle of the financial industry jargon giants, QCD versus DAF, and a viewer had a question as we talked about qualified charitable distributions and donor-advised funds and asked, “Wait a minute, qualified charitable distributions, that's the required minimum distribution, right? What's the difference exactly between those things because it all comes from IRAs?”
That's a great question. We love viewer questions. And on this episode of Friends Talk Financial Planning, we're going to explain exactly how those things are related, but why they're different. And then also talk about one sort of hidden trick in the Secure Act that can help people who maybe don't need to take minimum distributions save money on their taxes when they give to charity. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. And before we get into RMDs, and QCDs, please subscribe. That helps more people find our channel. So, John, what do have to say? Let's start it out.
John: Yeah, first of all, we love it when we hear from people who say, “I was looking at this and know I've got a question.” That's the type of stuff that's really engaging for us. And I love this question. As you and I were talking before we hit record, we deal with this stuff all the time. We understand that when you get into this jargony thing, you might go, “Wait a minute! What’s the difference between these two things? I know they're tied to an IRA, and it applies when you're in your 70s. But what's going on here?”
So let's break this down. Let's just start with the question: what is the required minimum distribution, RMD, from your IRA? We get into some of these acronyms with things. The required minimum distribution is quite literally what it sounds like. It is the minimum amount that the IRS requires you to distribute from your IRA once you reach a certain age. It used to be age 70 and a half, and then the first Secure Act changed it to 72, and now it's 73, but it's actually going to go up to 75. But when you hit that age, you have to take out a certain amount of money from your IRA.
The deal is that money went in all pretax, so the IRS wants its money at some point. And what happens with that is that there's a formula, something like 4% or so when you're in your early seventies, and it grows so that by the time you're 90, I think it's around 8% of the value. And so, here's an example. Say that I have a million-dollar IRA, and I’m somebody who's not spending any money from my portfolio. Maybe I've got a pension, maybe I got other things going on—real estate, income, something—so I don't need the money from my IRA.
I got a million dollars. The IRS says, hey, once I'm 72, 73, I need to take out $40,000 or so a year and pay taxes on it. That is the minimum distribution. If I’m somebody who’s spending money, right, I don't have a pension or other income. I need that money in my IRA to live on. Maybe I'm taking out $50,000 or $60,000 or $80,000 a year from my IRA. Great. The IRS says I have to take out $40,000. I can take out as much as I want to, but in that scenario where, jeez, I don't really need the money, they sort of make you take that money out.
That's the deal. And when the money comes out, then it's taxable. It's like regular income. So that's sort of the core of this required minimum distribution. Once you get to be in your early seventies, you have to take at least this much money out. And if you don't, then there are some penalties with it. So that's what the RMD is. I don't know if you have anything to add to that.
Bridget: A couple of points. One, you can take money out of your IRA after 59 and a half, but you're just required at age 73 if you were born before 1960, and now they moved it up to 75 if you're born after 1960. That’s January 1 of 1960, so it makes it easier. I appreciate that. So that's the cutoff point. And again, that is a relatively new law that just got passed at the beginning of the year, upping the ages, and then you're just required to take some money out.
John: Yeah. Right. And these things are confusing. I tell you what. We were joking before. When I go to the doctor, they take my blood pressure, and I know the numbers, but systolic and diastolic. What is that? That doesn't mean anything to me. But required minimum distribution, if you stop for a second and think about that, you can say, “Oh, yeah, that's the minimum amount I'm required to distribute when I get to that age.” It really tells a story. What about the qualified charitable distribution, the QCD?
Bridget: Yeah. The qualified charitable distribution. This kicks in at age 70 and a half. Once you're 70 and a half, if you want to take up to $100,000 and donate it directly to a charity, you can. And you bypass the tax.
John: And donate it directly to a charity from your IRA. That's what we're talking about. I take IRA money and send it right to charity. This does not hit taxes in any fashion. It’s all pretax money going to charity.
Bridget: Exactly. This is a great way to donate to charity if you're over 70 and a half. It's a very tax-efficient way to do it if you have money in your IRA. And you can get a checkbook. We detailed this in other episodes. You generally get a checkbook from your custodian. We work with Charles Schwab, which provides a checkbook. If you lose your checkbook, you can get another checkbook, and you can just write a check directly to a qualified charity. It does take a bit for them to clear. And again, we've had episodes that detail it. But in this episode, we really want to talk about how they interact. How do these interact?
John: It's funny, I'm sitting here thinking about the required minimum distribution. Think about those words. Yep, that explains it. And you just described the qualified charitable distribution. Okay, I'm going to qualify a distribution from my IRA to a qualified charity. And you go, “Okay, that's the thing.” These are two separate things. What's confusing about that? And here's the connection. When you give money to a charity using a qualified charitable distribution, that can satisfy the requirement to take a distribution from the IRA.
All distributions from IRAs are going to be taxable in general. 90% of the time. This is the one exception where if I write that to charity, that counts toward that minimum distribution. When I do other things, like a Roth conversion, I pay taxes on that, but that does not count toward the required minimum distribution. When I do other things, it doesn’t count, but this qualified charitable distribution can satisfy that need. It's two separate things, but they're connected in that fashion. I think that's the best way to explain it. Does that make sense?
Bridget: Yes. We used that example before. The person had a million dollars in their IRA. When they're 70 and a half, they can start saying, “Hey, maybe I'm not itemizing, maybe I just want to give money to charity, maybe get credit for it.” I think people like getting credit for giving money to charity. All right, so I want to get some credit for this. I'm 70 and a half. I don't have to take any money out of my IRA yet, but I'm going to get a checkbook, and I'm going to start writing my checks to my qualified charities from my IRA. Then you're going on and you reach 73. Okay, now at 73 this person says, “I'm going to give $10,000 a year out of my IRA.” They reach 73.
John: And when you say $10,000, I want to be clear, I'm not taking that to spend. My goal in this scenario is to give $10,000 to charity every year, right? Is that what you're saying?
Bridget: Yeah, exactly. It's going to the qualified charity with the checkbook provided by the custodian. So then you reach 73. Now I've got to take the required minimum distribution. I find out generally from your custodian, or you can calculate yourself how much you need to pay in your required minimum distribution. But let's say it's about $40,000. Okay, so I'm going to pay $40,000, but I still want to give away $10,000. So then all I have to do is take out $30,000 as a required minimum distribution, and I can give away the $10,000, and that counts.
John: Yeah. Let me just pull that out a little bit because I love that scenario. And I've got a client situation I'm thinking about. Something along the lines of, hey, I need to take out $40,000 because it's required for my minimum distribution. I don't need the money necessarily to live, but I want to give $10,000 to my church or to United Way or wherever, so I write a check from the IRA to church and to charity to United Way, and I give $10,000 away. I need to give out $40,000. I've given away $10,000 from that. Now I need to take the other $30,000 and put it in my pocket, or put it in my investment account, and pay taxes on that. That satisfies the minimum distribution of $40,000, and $10,000 of it to charity.
Bridget: Exactly. That's exactly explained. The other person could say, “You know what? I want to give the whole $40,000 away.” Fair enough. Write the checks to charity and then they won't even show up. Well, you know what? It'll show up on your tax return in one box, but then it'll have a little QCD typed in that you probably would miss. I mean, I see it. And then the taxable amount will be given.
John: Yeah, we have a lot of folks that do that too, and maybe their RMD, the required minimum distribution isn't quite as high as $40,000, but they say, “Listen, I have to take some of this money out of an IRA. Golly, I don't need the money. I could pay taxes and save it, but why don't I just take that minimum distribution amount that we need and use the qualified charitable distribution to give it all to charity.” And maybe you don't have a goal.
You don't want to give $10,000 or $5,000 or $15,000, but when it comes up, you go, “Listen, I have to take this out. Why don't we wipe out the taxes and just give it to charity? We'll figure it out each year.” And that's where those two numbers can be the same then, right? My RMD, my minimum required distribution, and my qualified charitable distribution might be the same thing. They aren't the same thing, but the numbers might be the same.
Bridget: Right.
John: Let me throw one other scenario out at you. I love this idea of real examples. I need to take out $40,000 from my IRA, but I'm a little bit more charitably inclined. I usually give $50,000 a year to charity or $60,000 a year to charity. How can I be efficient with that?
Bridget: Just write all the checks from your IRA. As long as that works for your overall financial picture, use your IRA. You can give up to at least $100,000. And if you're getting to that edge, I think they changed it in the Secure Act so that it's going to be inflation-adjusted, so it'll start edging up a little bit higher. You can give at least $100,000, maybe a little bit more, and that's just fine. If you want, you have to take $40,000, but you want to give $50,000 you can write it all out of that, up to $100,000.
John: And then again, that satisfies the required minimum distribution. So we put the goal first. What do I want to do? Do I want to give money to charity? Yes, or no? I want to give $50,000. All right, great. I’ll give $50,000. I can do it from the IRA using the qualified charitable distribution, because, like we talked about in the previous episode, that's a smart way to do it. And then separately, I can go, “Okay, how much do I have to take out? Oh, I only have to take out $40,000. I'm above that already. I'm good on that qualification.”
Bridget: Exactly. That's a great place to wrap it up, John. So, I'm Bridget Sullivan. I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients, so if you're interested in these things, please reach out. We'd love to talk to you, but we're also both members of the Alliance of Comprehensive Planners, which is a group of nationwide, fee-only, tax-focused financial advisors who think similarly to how we think. So if you like what you hear on our show and you want to find an advisor local to your area, you can check out acplanners.org.
Check out our previous episodes!
The Basics of Donor-Advised Funds
Maximizing Donor-Advised Funds
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