#116 The Strategic Role of Qualified Charitable Distributions in Retirement

Christian Sakamoto  00:03

Welcome back to the Plan Your Federal Retirement podcast. I’m your co host today Christian Sakamoto, and with me today is also another awesome advisor John Raleigh, John how you doing?

John Raleigh  00:17

Great Christian, how are you doing?

Christian Sakamoto  00:19

I’m doing really good. I’m excited for our episode today, I’m actually in Alaska, in our Anchorage office today. It’s always a good time when I’m up here and you’re you’re down in Florida, so I think we’re, couldn’t be further apart today, is that right?

John Raleigh  00:32

We’re about as far as we could be across this great nation, for sure. 

Christian Sakamoto  00:36

Yep, yep. So today we, as we were brainstorming what to talk about today, Micah wanted us to talk about some of the things that we’ve been talking about with our clients over the last few weeks as we’ve been meeting with them, and a common theme that came up was centered around charitable distributions and giving to different charities, so it kind of be a good idea that we talk about the different rules when particular, when it comes to qualified charitable distributions, we can talk about some of those rules and some of their importance. Now the end of the year tends to be the time where people in general, revisit where they’re going to be giving to different churches, charities, that sort of thing. It’s always that good time of year to be thinking about that, and so as this podcast is gonna be airing sometime early December, this would be something to be thinking about. So I’ll first start off and just share when it comes to qualified charitable distributions, the main benefit of them. We want to make a world a better place, right in all of these different organizations and different ways that we can support, and the tax code allows us to do this in a tax efficient way, and in particular, we can use an IRA to fund a qualified charitable distribution and get a nice tax deduction for it. So John, could you walk us through a little bit more detail there on how they work, and you know, just what they are in general.

John Raleigh  02:12

I’ve been working with individuals that have been very charitable in my area of the country is extremely charitable in a lot of things that they do, and QCDs or Qualified Charitable Deductions are a distribution, it’s a tax free distribution that does not count as income, but unfortunately, you also cannot deduct it on your tax return. They might say, well, why are we even talking about this? Well, what happens is, when you reach required minimum distribution age, it’s now 73 but in the past it was 70 and a half, you have to take money out of your retirement plan, that’s your TSP, that’s your IRAs, that anything that’s growing in a tax deferred situation that’s qualified, meaning you’ve never paid taxes on it. What people do is, normally they put off those distributions till sometime in the future. Reason being, why pay taxes now till you have to pay it sometime in the future, so let’s just keep putting it off. There have been many individuals that haven’t paid attention to this, and by the time they get to the point where they have these required minimum distributions in place, there’s a substantial change in the amount of income that they have. It’s not abnormal to see 15, 20, 30, 40, $50,000 a year of income that needs to come out of these qualified plants because they were never touched, that can substantially change your tax that you’re paying, and especially if you’re an individual, but even so, if you’re if you’re married, when you’re filing a joint tax return, that’s what makes these QCDs so special. They are actually a direct contribution to the charity from your IRA. Now we’ll talk later about it, can I do it from the TSP? We’ll talk about that in a little bit, but we’re talking specifically, they come from IRAs and the decisions that you make to have the money go directly to the charity. Because of that, you do not receive that money. That money goes directly to the charity. The taxes that are due on that money is not have to be paid by you, because it went directly to the charity, and the real benefit is it counts as part of your requirement of distribution, or your total requirement of distribution, for that piece of it. The big deal you have to understand with it, though, is it has to be a qualified charity, so when you make the choice of where to go, make sure that charity fits into the 501(c)(3), and is eligible for this tax deduct or deductible contribution. So that’s sort of a big overview there Christian.

Christian Sakamoto  04:57

I appreciate it, yeah, and I love that you highlighted too, that I think that’s really important as well, is that the qualified charitable distribution actually counts towards your required minimum distribution, and you know, because normally, if you want to take money out and do and shuffle things around when you’re of RMD age, Required Minimum Distribution age, you would have to do that first, and then you could do things like Roth conversion. Well, in this case, with the qualified triple distribution, you could use either some or all of your RMD and move it directly to the charity, tax free, and accounts for for that RMD for satisfying that which is really good, and we’ve got clients all across the board with different income and cash flow needs, so of course, this isn’t going to be right for everybody, but for those that took to your point, John, that maybe have delayed even touching their qualified plans, their IRAs, if they’ve delayed them and are sort of dreading reaching that required minimum distribution age. Well, this qualified charitable distribution could be a really good solution for them. Now we can talk also about some of those rules to just some of those specifics. So, John, what age can you do the qualified charitable distribution, and what’s the, what’s the, some of those details there on the limits?

John Raleigh  06:20

Well, when you’re looking at the limits, 70 and a half right now is the limitation, you have to be 70 and a half to be able to do these. Unfortunately, I would love, especially for you individuals that have retired early and might maybe want to control the size of these VSPs and retirement plans like that into the future that is not available to you at this point, and using maybe some of the other game plans that are there available to you in the interim would be good, but 70 and a half is definitely the key right now. We anticipated, probably sometime in the future, moving up the follow requirement and distribution rules, it just seems like Congress hasn’t gotten to that right now, with everything going on, you know, to be able to do that. Another limitation, which is absolutely fantastic, especially if you have the resources available, is each individual can give $105,000 a year to a qualified charity, or qualified charities as a total amount, and if you’re married, that doubles to 100 I mean 105 times two, which really, if you think about it, is a substantial amount of time to a lot of good, lot of good for individuals and charities in the future. Sad thing in the limitations, it can only be done from an IRA, not your TSP, not any 401 K type plans, right now, it’s just an IRA so that it that is a difficult one. Now, Christian, you’ve got a great example, as we talked about this before we came on to this presentation, about what happens though, on the reporting at 1099 it would probably be a good idea to go over that for us, just to show some people understand what happens.

Christian Sakamoto  08:07

Yeah, so just something to be aware of that when you take money out of an IRA or even a TSP every year, you’ll get issued for the previous year a 1099-R and box number one talks about and shows that dollar amount for the gross distribution, and right underneath that box 2a shows the taxable amount, or underneath that 2b asks the taxable amount is either it’ll there’s a checkbox there that says the taxable amount is not determined, and one of the downsides, I would say, with qualified charitable distributions is, if we don’t know exactly how much we gave to charity, and it just came all out of the single IRA, then you’re going to get this 1099, that comes in that it’ll show a gross distribution, and then it’ll say that the taxable amount isn’t determined, and the only way you’re going to know how much you did as a qualified charitable distribution, how much is actually taxable, is if you had really good record keeping to know how much you gave to a charity that year, so for a lot of our clients that give either on a monthly basis, or to multiple charities, it can kind of get a little bit trickier to track what that taxable amount is versus the tax free amount that qualifies for that for that QCD, so we just have to be aware of that. One of the things that we’ve done with our clients is we so one of the tricks would be we would open up a second IRA, and we would just nickname it QCD IRA. And every single year, we fill up from our main IRA into this secondary QCD IRA, which has all the same tax policies as the other IRA, but we just from record keeping for bookkeeping it keeps it a little bit simpler, and what we do is we take whatever amount that we were going to give for that year, that’s how much we put inside the QCD IRA, and then with the goal of emptying it down to zero at the end of the year, because then if we’re confused on how much we actually gave, we just look at the outflows from that QCD IRA, the distributions from that IRA to determine how much is, what would actually be tax free for that year, so again, that’s especially important if you are taking distributions out of the IRA, to know what’s that tactical number.

John Raleigh  10:37

The other thing too, Christian, which is interesting, I have had more questions, not only from CPAs, but also individuals that do their own taxes, because they’ll see, and let’s say you took $105,000 out of your your IRA, and you did a QCD, and the taxable amount listed there is $105,000 you can imagine the shot when if you put it into TurboTax, or one of those tax reporting programs yourself, and all of a sudden you have tax due on $105,000 of extra income that you weren’t anticipated or better yet, maybe you don’t have great communication with your CPA, or maybe you’re using a tax preparer, and they’re doing tremendous amount of tax returns during that time of the year, and they just see to $105,000 put it in as a taxable distribution, now, all of a sudden, the clients calling the advisor up and saying, what’s going on? I have $30,000 extra taxes or whatever that’s due, there is something not right, and it’s just because they didn’t pay attention to 2b where it says the taxable amount was not determined, so the individual person doing their own taxes, so.

Christian Sakamoto  11:47

In no fault of the CPA, right? This is really just, if we are going to do the qualified trouble distribution that’s just one way we found that makes it simpler, so the big thing, I would say, for our listeners is for those who are charitably minded and have this goal, we have to really understand the rules, so make sure you’re working with an advisor and CPA on this, or tax repair on this, and make sure you’re especially working with someone who understands the federal rules as well and understands how the TSP works, because to your point, John, you hinted at this earlier, the TSP doesn’t allow for these qualified charitable distributions, right? You have to first transfer money out of the TSP into the traditional IRA, and then once it’s in the traditional IRA, we can then do the roth conversion. Now this will be also true for you know 401 K, 403 B we can’t do qualified charitable distributions in those either the TSP has the same rule there, so we’d have to first do that transfer, and I’m just saying, hey, make sure when you’re working with your advisor on that transfer that you’re working with someone who really understands the rules inside the TSP and how they work, that’s all.

John Raleigh  13:00

And understand communication is important, because whether it’s a CPA or a someone that’s preparing your taxes for you, they need to know what that taxable amount is, it’s the person paying the taxes responsibility to communicate that. It’s also you’ll figure it out, if you are using a tax preparation program, you’ll find that out when you run it the first time and see the numbers are very out of whack, because you showed it as all being taxable, and then you’ll go back and say, well, really what happened? Or like lions have done, go up and say, I don’t understand it, my taxes are way higher, what’s going on? And, believe it or not, if you’ve done QDCs that’s the first place I start with is, what do you check into the box and what’s in that box, because that’ll help answer it quickly.

Christian Sakamoto  13:46

Yeah, and in summary, the impact that qualified charitable distributions have, we talked about how we can apply them for RMDs, right? We have to be 70 and a half, but they account towards our RMD which is good to know, but just from a math perspective, if let’s say for round numbers, that the goal was to give $1,000 to charity, and if we want to, we can add a zero to that, so let’s say, yeah, let’s say $10,000 was our charitable goal for the year, that’s a big goal. Well, if let’s say we’re in the 22 or 24% tax bracket, if you took $10,000 out, you know you’re not, at the end of the day, you’re not actually getting $10,000 if you were to then take a distribution and then give it to the charity, so this is a really helpful way to just take $10,000 without taking the taxes, giving it directly to that charity, and then they get to, then get that distribution tax free as well, so there’s quite a bit of tax savings there that we can quantify again, if you’re, let’s say you’re in the 22% tax bracket, plus state has a state tax as well, so you know, there’s significant tax savings by doing these, which, again, I think they’re a really good tool. 

John Raleigh  15:04

Yeah, it’s interesting, I know if you, if you ask the majority of clients that I work with what their goal is with regards to taxes, most of them will say, I’m willing to pay my fair share, but I don’t want to pay any more than my fair share, right? This is one way to be able to do charitable gifting from qualified plans, where actually you can reduce your fair share because you’re following the rules that are put in place to do this, and it makes it extremely powerful, and like you said, Christian, whether it’s 1000 or 10,000 or 100,000 I mean, it’s a substantial savings for the individual that are giving it, and think about it, that money that you would have paid the taxes the charities now able to use to reach their goals, which is really important.

Christian Sakamoto  15:55

Yes, yes. Now I’d say one last I guess planning opportunity would be centered around bunching those gifts and doing it kind of as a lump sum, so John, do you have experience with clients that maybe have done a large QCD and sort of bunched up their gifts into one tax year to see some tax savings in addition to just doing it every single year, do you have any experience with that?

John Raleigh  16:25

I mean, there’s a lot of examples there that, and as people get into retirement, and as they begin, especially if they’re working with somebody that has helped them understand that they’re not going to run out of money, which is a big fear, like that, they start looking at the things they can do to make the world a better place, and I’ve had clients wanting to do things like scholarships first, whether it be specific majors at school, whether it be for athletics, for whatever the situation is, whether it’s churches with whatever that is, they’re able to go and sit there and say, okay, how is the best way to do this, but how will I be least affected by? And like you said, by bunching those particular pieces together and working within the tax codes, it can make a substantial difference, because if I have a $50,000 requirement of distribution from my IRAs or retirement plans this year, and I don’t need that money because I have other sources of income coming in that are meeting my lifestyle and meeting my lifestyle need, but I still need to take this distribution and I can give it to a charity in whole, as opposed to in after tax dollars, which means the charity receives less and taxes that are paid, it can make a significant difference, so I mean, the examples are endless, and they’re specific to a lot of times to the individuals, and that’s just the thing there, it depends on what your needs are, what you’re looking to do, and how you’re trying to do it, but what can happen is endless, and it’s exciting, and it can really make a significant difference if it’s just done right. 

Christian Sakamoto  18:10

Right, and for those federal employees, federal retirees, who are charitably minded, that’s there’s some neat tax planning signs that are secondary to making the world a better place, right? Which I think ties into the action item for today. This is a podcast about taking action, it’s great to listen to us talk, but we want to make sure that we’re actually doing things to make our retirement plans even better, and I say the first action item is really to come up with, if you feel so inclined to come up with your charitable giving plan, and so if that is, you figuring out how much you want to give, where you want to give money to, it’s good to have goals, and we talked about in financial planning, setting those goals, we shouldn’t forget to also have goals centered around charitable giving as well, and again, making the world a better place is our first goal, Tax Planning comes underneath that, and qualified charitable distributions just happen to fit really well into that, into that secondary goal there, so what’s another action item John?

John Raleigh  19:20

The most successful people you’re going to run across to the retire, they know their retirement income, where it’s coming from, and their retirement income timeline, and understanding those pieces and as being a fed you have an amazing piece of place, and that’s with your pension that you receive, if you’ve qualified for it and you’ve been and you’re receiving it, people don’t understand how strong that is, because outside of the federal work, there’s not a lot of those pension pieces in place anymore, so you have a tremendous source of income that’s available that if you understand where it’s coming from, you make sure your needs are not only met, but will be met into the future, it then allows you to really be able to sit there and say, if I’m charitable minded, this is what I can do, you know, so knowing that timeline is key.

Christian Sakamoto  20:14

Yeah, absolutely. Well, last action item, as always, subscribe or following our podcast wherever you happen to be listening to podcasts. Our goal is to impact another million federal employees, and so we can’t do it without your help. Well, John, this was a lot of fun, I appreciate your insights onto qualified charitable distributions, as always Happy Planning!

John Raleigh  20:43

Happy Planning!