When you started out saving for retirement, you may have contributed to an IRA or 401(k) through your employer. In addition, you heard that your contributions were tax-deferred, and you’d have to pay taxes when you reached your 70s. But at the time, you didn’t have to pay income taxes on whatever you contributed, so that may not have been your biggest concern.
Well, now that you’re either in or approaching that age, you need to think about both your Required Minimum Distributions (RMDs) and the tax burden associated with each distribution. Unfortunately, the more you had saved in your traditional IRA or 401(k), the more taxes you must owe when it comes time to take your RMDs.
In retirement, more income isn’t always better. Remember, you’re paying yourself, so by turning your wealth into income for a certain year, you’re signing up to pay the IRS a hefty chunk of that money. When you’re in retirement, you don’t want to be paying yourself more income than you need, but RMDs force you to take a certain level of income which can pose an issue for a tax-optimized retirement financial plan.
The good news is that there is a way you can control your tax burden and rearrange your financial habits to help you do so. The Qualified Charitable Distribution (QCD) is a way to reduce your RMD tax burden. First, if you’re using a 401(k), you must roll your holdings over to an IRA to make QCDs. By directing your IRA to distribute directly to a qualified charitable organization listed by the IRS, you can turn your distributions that would have forced you to take taxable income, into tax-deductible contributions to your favorite charity.
If you already give to charitable organizations, whether a religious institution, a community organization, or an organization championing a cause you support, you can maintain your charitable habits as well as save on taxes, helping you keep more of what you worked so hard to save. But before making charitable contributions, make sure you know the ins and outs of the QCD rule so that you don’t make a costly mistake!
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[1] https://www.kiplinger.com/retirement/qcds-offer-tax-break-when-rmds-loom-large