If supporting charitable causes close to your heart is part of your retirement plan, there are two popular options worth exploring: a donor-advised fund (DAF) and a qualified charitable distribution (QCD). Here’s what you need to know about each option and how to use a DAF or QCD in retirement.
A donor-advised fund is an account dedicated to charitable giving. The preferred way of funding is to contribute appreciated stock from a brokerage account into the DAF. Not only does the donor receive a charitable deduction in the year of contribution, but they also avoid paying capital gains tax on the appreciated stock.
A qualified charitable distribution is not an account, but an actual distribution from the donor’s Individual Retirement Account (IRA). In doing so, the donor does not receive a tax deduction but instead removes pre-tax ordinary income positions from their portfolio without paying the ordinary income tax on the distribution.
| DAF | QCD | |
|---|---|---|
| Actual account | Yes, and one that can be invested for future use | No – Typically a check distributed to the charity |
| Tax Deduction | Yes, if itemizing deductions | Not directly |
| Age Restriction | No | Yes – 70.5 |
| IRA Required | No | Yes, and must be an IRA not 401k etc. |
| Ability to Fund in years prior to donation | Yes, contribute in highest tax rate years | No, distribution goes out in year of request |
| Satisfies RMD | No | Yes |
Under Age 70.5
DAF is likely to be your best option if you are younger than 70.5, especially if you have a brokerage account with appreciated stock.
Given that the DAF contribution results in a tax deduction, a key factor is when and how much to fund the DAF.
Let’s take a pre-retiree executive who is 60 and plans to retire at 62. Her household income of $550k puts her in the 35% tax bracket. Annually, she averages giving about $40k to various charities and plans to continue this in retirement. A tax-inefficient way to do this is to write checks each year or even contribute to a DAF each year.
The better way is to make contributions to the DAF in years of highest income. The key here is to make a larger contribution during the high-income year that will cover planned donations over many years to come, especially those years of low taxable income.
So, in this example, she could contribute enough in her 2 remaining working years to at least get her to age 70.5, when QCDs could possibly start. Let’s proceed with round numbers and assume 8 years’ worth of $40k contributions need to be in her DAF before she retires. So $320k of appreciated stock could be moved to the DAF from her brokerage account. Logistically, I would want to split this over 2 years at $160k each.
This also takes into consideration the annual deduction limit of up to 30% Adjusted Gross Income (AGI).
Other items for you to consider:
- Any retirement-related bonus
- Deferred Compensation that lasts a few years post-retirement
- Roth Conversions or other Pre-Tax distributions that would increase tax brackets
- When do you plan on starting Social Security?
Between 70.5 and RMD Age (73-75)
During this period, the same now-retired executive we discussed earlier would have the option to continue using their DAF or start QCDs. Decisions during this stage should weigh the benefits of an immediate tax-year deduction against lower future tax liability.
Here are some specific situations that can impact which route to take:
- Consider how much of your portfolio is in tax-deferred accounts compared to brokerage or Roth IRA accounts. If your portfolio is very heavy 401(k)s/IRAs, then using the QCD option would help lower future required minimum distributions. To utilize QCDs, the IRA must be used, so any old 401(k) account would need to be rolled over first.
- If you have a heavily weighted brokerage account, especially one with a very low cost basis and therefore higher appreciated stock, then you could consider continuing the DAF. This would also apply if no IRA exists as a result of Roth Conversions from prior low-income years.
In general, though, ordinary income tax rates are higher than capital gains tax rates for most taxpayers. So, in that regard, if in the 22% ordinary income tax rate and the 15% capital gains rate, for example, then you may prefer to pay tax at that lower rate and lower future RMDs by using the QCD. This is where you want to consider your tax rate not only for the tax year you’re in, but also what your rate is expected to be in the years ahead.
Other items for you to consider:
- Do you know which charity you want to donate to? With a QCD, you’ll need to know when requesting the distribution. Whereas with a DAF you could hold the funds in your DAF account for many years until you know for sure which charity.
- Are you itemizing your deductions on your tax return? If not, then the DAF contribution won’t result in a tax deduction. Therefore, you would want to either increase that contribution or utilize the QCD.
- If you’re concerned about unrealized gains in the brokerage account, remember that capital gains are 0% Federal tax up to $49,450 of taxable income for single filers and $98,900 for joint filers. So, if able to realize those gains at 0% tax rate, then the QCD makes more sense. Additionally, consider any carry-forward realized losses from prior-year returns that could offset realized gains.
RMD age and beyond (73-75)+
Required Minimum Distributions (RMDs) for those born between 1951 and 1959 will start at age 73, and for those born in 1960 or later, at age 75.
While QCDs don’t get you a tax deduction, they do count toward your RMDs, and this is where one is highly likely to want to pursue the QCD at least up to the RMD amount over doing the DAF account.
Other items for you to consider:
- Be sure to notify your tax preparer that you completed a QCD during the tax year, as year-end 1099-R tax documents don’t always make that obvious or even state that at all, and the tax preparer would incorrectly report the distribution as taxable income.
If you have questions about how to approach charitable giving in retirement and are interested in learning more about whether a DAF or QCD could be the right choice for your situation, set up a time to talk with an advisor.
