Maximize Charitable Giving: Understanding 401(k) and IRA QCD Options

Investors can use their IRA accounts to make qualified charitable donations (QCDs), also called qualified charitable distributions. These tax-free QCDs are used to lower tax burdens by donating some or all of your account distributions, such as a required minimum distribution (RMD), to a qualified charitable organization and deducting those distributions from taxable income. Investors must take required minimum distributions (RMDs) from a traditional IRA or 401(k) at age 73 or 75, depending on when you were born.

You make such donations with traditional individual retirement account (IRA) distributions, but not with 401(k) distributions. If you want to donate using your 401(k) funds, you’ll either have to pay tax on them first or roll them into an IRA and then contribute.

Read on to learn more about QCDs and how to make the most of them.

Understanding Qualified Charitable Donations (QCDs)

With some types of retirement plans, including traditional IRAs and 401(k)s, you must generally start taking required minimum distributions (RMDs) and paying tax on them once you reach a certain age. Making a QCD is a way of contributing some of that money to a charity without having to pay tax on it.

You generally must start taking RMDs from an IRA or 401(k) when you turn 73 if you were born between 1951 and 1959 or 75 if you were born in 1960 or after. If you were born in 1950 or earlier, you had to start taking RMDs at age 72.

With Roth IRAs and Roth 401(k)s, you make contributions with after-tax funds and make withdrawals tax-free. You are not required to take RMDs from a Roth IRA during your lifetime. Nor are you required to take them from a Roth 401(k).

To make a QCD, you instruct your IRA trustee to pay the money directly to the qualified charity. Your spouse can also make a QCD from their own IRA, if they’re eligible.

All contributions and earnings that accumulate inside a traditional IRA are eligible for QCDs. Roth IRAs are generally not eligible for QCDs because the distributions are already not subject to income tax; however, you can make QCDs from other types of IRAs, including:

• Rollover IRAs
• Inherited IRAs 
• Simplified Employee Pension (SEP) IRAs (inactive plans only) 
• Savings Incentive Match Plan for Employees (SIMPLE) IRAs (inactive plans only)
  

How to Roll Over Your 401(k) Into an IRA for QCD Benefits

You may consider rolling the money in your 401(k) plan into an IRA when you change jobs or retire. That way, you can take control of the money while also maintaining its tax-advantaged status. Either way, you’ll be subject to RMDs at a certain age—73 or 75—depending on your birth year, as noted above.

A rollover won’t have any tax consequences if the money goes into a traditional IRA and if you follow the rules. However, if you roll over funds from a traditional 401(k) into a Roth IRA, you will have to pay income taxes on that money.

Once the money is in the IRA (and once you’ve reached the age for RMDs), you can use it to make a QCD.

Alternative Tax-Efficient Charitable Giving Strategies

You can donate to charity in many other ways as well. For example, once you’ve reached age 59½, you can take penalty-free distributions from your 401(k) and then donate directly to any charity. You’ll have to pay income tax on distributions from a traditional 401(k), but not from a Roth 401(k).

You may be eligible for a tax deduction if you itemize your taxes. If you make a qualifying contribution, which is a cash contribution to a qualifying charity, you can generally deduct it for up to 60% of your adjusted gross income.

You can also donate appreciated securities, such as stocks, to a charity. With this strategy, you wouldn’t owe capital gains tax on the securities, as you would if you simply sold them and donated the cash. In addition, you would be eligible for a tax deduction equal to their full market value.

The Bottom Line

A QCD is a way to get tax advantages for your charitable contributions, such as a reduction in your taxable income. QCDs can be made from various types of IRAs, but not directly from a 401(k) plan. However, if you rollover your 401(k) into an IRA, you can then make QCDs from that account.

The rules on traditional IRAs and 401(k)s mandate RMDs, generally starting when you turn 73 or 75 years old, depending on your birth year.