The SECURE Act became law on January 1, 2020 and made a number of changes to retirement plans that are beneficial to retirement savers and investors. One of these is the repeal of the age limit of 70½ for making Traditional IRA contributions.
As long as you are working and have earned income, you can keep contributing money to your Traditional IRA for as long as you want. If you’re continuing to work in your 70s and beyond, this could enable you to enhance your long-term retirement financial security by making IRA contributions indefinitely.
SECURE Act’s Impact on QCDs
However, the SECURE Act made another change that’s not as beneficial for individuals who want to utilize a strategy is known as a Qualified Charitable Distribution (QCD). With a QCD, you can contribute up to $100,000 per year to your favorite charities directly from your Traditional IRA if you are over age 70½. This distribution is not counted as taxable income when filing your tax return, so it doesn’t increase your adjusted gross income (AGI).
The change — which is commonly referred to as the QCD anti-abuse rule — effectively closes a loophole created by the repeal of the age limit for making IRA contributions that could have been used to abuse QCDs. The QCD anti-abuse rule prohibits Traditional IRA owners who are over age 70½ from making IRA contributions and then immediately donating them to charity via a QCD.
Doing so would result in a double-dip of tax benefits. The account owner could deduct his or her Traditional IRA contributions and then turn around and donate the same contributions to charity on a pre-tax basis using a QCD.
An example helps illustrate this: John is 71 years old and his total income last year was $50,000. He made a tax-deductible contribution of $7,000 to his Traditional IRA, which lowered his AGI for the year to $43,000. He then made a qualified charitable distribution of $7,000 to his favorite charity. Since he made a tax-deductible IRA contribution and a QCD, he got twice the tax benefit allowed.
To prevent this, John must add back to his taxable income any IRA contributions that he deducted after he turned 70½. Once the amount of his post-age 70½ deducted contributions reaches the amount of his attempted QCDs, any excess amounts above this can be treated as QCDs.
Calculating Allowable QCDs
Here is a four-step process you can follow to calculate the allowable amount of a QCD that accounts for the impact of Traditional IRA contributions made after age 70½:
1. Figure out the amount of current-year distributions you made that were intended to be counted as QCDs.
2. Determine the total amount of remaining distributions that will be denied QCD status. This would include Traditional IRA contributions you made after age 70½ less any QCD amounts that were disallowed in previous years.
3. Calculate any current-year distributions that will be denied QCD status. This will be the lesser of the first two calculations.
4. Now you can calculate the amount of current-year distributions that can be treated as a QCD by subtracting the amount from step #3 from the amount from step #1.
Crunching the Numbers
Let’s go back to our example. Suppose John made the same $7,000 tax-deductible contribution to his IRA the previous year when he turned 70½, or a total of $14,000 in contributions. Now he wants to make a $20,000 QCD. He can only designate $6,000 as a QCD since he deducted $14,000. His taxable income for the year is now increased by $14,000 due to the disallowed portion of the QCD.
John can still make a QCD of $6,000 and deduct the $14,000 as an itemized charitable contribution. For this strategy to work, he’ll still need to attempt to make the QCD as if he did not make deductible contributions after he turned 70½. If he bypasses the QCD process, he won’t be able to eliminate this amount from previously deducted amounts.
If John attempts to make the $6,000 distribution a QCD without following the QCD rules, he will still have a $14,000 balance in his deductions that will work against future potential QCDs. But if he follows the rules and makes no future deductible contributions, he has now offset the amount of his prior deductible contributions. In future years, he will be able to apply the full amount as a QCD.
The details of the QCD anti-abuse rule can be complex. We encourage you to discuss planning strategies with your financial or tax advisor in light of this new rule.