How Seniors Can Donate More to Charity and Pay Less in Taxes

It’s the season for charitable giving—and for seniors to make sure they get the best tax breaks for their donations. Hint: If you’re writing checks for cash to charities, you’re probably missing out. While all Americans can get tax breaks for giving, those 70½ or older have the best choices. They include strategies that can reduce a range of taxes, offset income from Roth IRA conversions, or bypass capital-gains taxes. Givers in their 60s should take note and factor them into long-term planning.

But many seniors are unaware of these moves, especially two key tax-favored ways to give: qualified charitable distributions, or QCDs, and donor-advised funds, or DAFs. In a survey of people with at least $1 million of investable assets who are either retired or approaching retirement, less than 40% were aware of either one, according to a study released this year by Fidelity Charitable, an affiliate of Fidelity Investments.

It’s too late to take advantage of QCD and DAF strategies for 2024. But, these moves will likely be useful for 2025, ahead of the expiration of the 2017 tax changes at year-end—but that will depend on what Congress does. Because QCDs and DAFs are quite different, it’s useful to consider them side by side. Here’s more about each.

Qualified charitable distributions

QCDs allow savers 70½ and older to donate pretax funds directly from traditional IRAs to charities and owe no income tax on those withdrawals. The QCD limit is $105,000 for 2024 and $108,000 for 2025 for each IRA owner, and the total can include many separate donations. QCDs offer a way for donors to get charitable tax breaks while still taking the standard deduction, which is the amount taxpayers get if they don’t itemize deductions on Schedule A. If donors take $500 out of their IRA and donate it, that could cost another $120 in federal and state taxes. With a QCD the tax would be $0. QCDs are highly tax efficient.

The benefits don’t stop there. Up to the limits described above, QCDs can be subtracted from required minimum distributions, or RMDs, that many owners of traditional IRAs must take annually. So, if a saver has a $40,000 RMD and $7,000 of QCDs, the donations can reduce taxable RMD income to $33,000. This has ripple effects: Shrinking the taxable RMD reduces a filer’s adjusted gross income, or AGI, which could lower the amount owed for the 3.8% surtax on net investment income or raise deductions for medical expenses. Lower AGI can also reduce Medicare IRMAA surcharges.

Shifting cash gifts to QCDs can help savers with Roth IRA conversions as well. Consider the example above, in which a donor reduces his taxable RMD from $40,000 to $33,000 by making $7,000 of QCDs. In that case, he could convert $7,000 of IRA assets to a Roth IRA and still have a taxable income of $40,000. So, what’s not to like about QCDs? In a word, hassles.

QCD donors either must have their IRA sponsor cut checks for the charities or write checks directly from the IRA. Then they must make sure the charities receive the checks and cash them before year-end. Donors also need proper acknowledgments of the gifts. And—most important—they must remember to subtract the QCDs from taxable IRA withdrawals on their tax returns; IRA sponsors aren’t required to break out QCDs on the 1099-R form. That’s a lot, but the QCD tax benefits can be worth it.

Donor-advised funds

DAFs have no age restrictions, unlike QCDs, but they appeal to many older Americans who are finished with retirement saving, tuition, and mortgages and want to step up charitable giving. While many of the tax breaks of DAFs are available to donors making direct gifts to chosen groups, DAFs provide convenience and flexibility. With a DAF, a donor gives money or assets to a dedicated account at an umbrella charity—known as a sponsor—and gets a tax deduction that year. Donors can then postpone further giving decisions until they’re ready, and the funds can be invested and grow tax-free until disbursement to specific charities. There’s no further deduction then.

There are a variety of sponsors. Financial firms like Fidelity, Schwab and Vanguard have charitable affiliates with DAFs, and community foundations offer them. For donors, DAFs can be as gloriously free of hassles as QCDs are loaded with them. When donors with DAFs are ready to make donations to specific groups, they tell the sponsor. The sponsor must approve the donation, but it will almost certainly be allowed if it’s to a 501(c)(3) nonprofit. Sponsors then handle the paperwork, making it possible for many donors to do a year’s worth of giving in a few minutes. Donations can be anonymous, if desired.

For many donors, however, the tax breaks for DAFs will not be as good as the ones for QCDs. For gifts under the $105,000 limit, nine out of 10 times the QCD will be more tax efficient.One reason is the currently high standard deduction, because donors must choose between taking it or an itemized deduction for a contribution to the DAF sponsor. This is why some donors bundle several years’ worth of gifts into one year, allowing them to take the standard deduction in others.

DAF deductions also don’t reduce adjusted gross income, or the taxes linked to it, as QCDs can. That’s because itemized deductions on Schedule A come below AGI on the tax return. Then again, donors of appreciated assets like stocks can deduct the full market value without owing capital-gains taxes on the appreciation—something QCD owners can’t do. By lowering taxable income, these deductions help lower taxes on other income, such as from Roth IRA conversions.

But donations of appreciated assets are restricted to 30% of the donor’s AGI, with the excess carried over up to five years. These donors also give up the valuable step-up at death on those assets. Despite these disadvantages, DAFs can be a great choice for givers, especially if they’re making donations of six figures or more, or have small IRAs and large taxable accounts with appreciated assets. Some donors use both QCDs and DAFs.

The bottom line: Donors who give strategically can do well while doing good!

This article is provided for educational purposes only. Bluffton Community Kitchen does not offer legal or income tax advice.