Power Up Wealth podcast – Who Wants to Save on Taxes? – Episode 34 transcript:
Sharla Jessop 0:00
Everyone likes to save money. This is especially true for seniors when it comes to taxes. I’m Sharla Jessop, and today we will dive deeper into a valuable tax planning strategy with my friend and colleague Jordan Hadfield.
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
Jordan, thanks for joining me today.
Jordan Hadfield 0:49
Yeah, I’m excited to be here.
Sharla Jessop 0:50
Jordan is a private wealth consultant with Smedley Financial. He holds a Certified Financial Planner and Behavioral Financial Advisor designation. Jordan, what is this tax strategy? And why is it so valuable to seniors?
Jordan Hadfield 1:05
So we’re talking about the QCD or the Qualified Charitable Distribution. The reason why it is so exciting for seniors is because they have what’s called an RMD, or a required minimum distribution from their IRAs. Basically, a tax deferred IRA has tax advantages. When you add money to the IRA, you don’t pay tax on it. Well there comes a point in time where the government says, okay, enough tax benefit, we want to collect our taxes. So they force an RMD. A required minimum distribution that needs to come out every year. When that money comes out of the IRA, it is taxable. It’s taxed as W2 income that goes on on top of your taxes. And if you’re in the 22%, federal tax bracket, 5% state, then you’re going to pay, you know, roughly 27% on that distribution. For a retiree who’s on a fixed income, managing taxes becomes very, very important. And sometimes, these required minimum distributions can add some tax liability that’s unwanted, particularly if a client doesn’t need to take the distribution from their IRA. So that’s where the qualified charitable distribution comes in, the QCD. If you donate part of your RMD, or all of your RMD, to a 501c3 Corporation, a charity of any kind, that could be a church, it could be a hospital, it could be a school, it could be a private foundation, then we can take tax deferred money out of an IRA and convert it to tax free money. So it’s a win on both sides. We send that money directly to the charitable organization, and you don’t report it as income on your taxes. This is beneficial for multiple reasons. Like I said, we’re taking tax deferred money converting it to tax-free money, we’re not reporting it as income. So it doesn’t affect social security, or IRMAA for Medicare for you know, for people who have higher income, and we’re not paying any tax on it. It’s a fantastic tax-saving strategy for those that are 70 and a half or older.
Sharla Jessop 3:09
Many people who make charitable donations claim it as a deduction on their taxes. So why is a QCD more valuable than just taking it as a taxable deduction?
Jordan Hadfield 3:21
Yeah, this is a great question. And this is one that’s important to understand. Because a lot of people say, oh, well, yeah, I get the deduction. A QCD is very different than a donation to a church. Most people take the standard deduction. And if you’re taking the standard deduction, then you’re not getting credit for the donations to the charity, because you’re, that’s calculated in the standard deduction, right? A QCD works on top of that. So it’s almost like you’re legally double dipping. You’re gonna take the standard deduction, and then you deduct the QCD amount on top of that. So again, if you’re taking the standard deduction and you’re making donations, you’re not necessarily getting a tax deduction for those donations. Now, if you’re not taking the standard deduction when you’re itemizing. Now, if we make a contribution, and we itemize, then we are getting credit for that, but that income is counted towards social security and Medicare, IRMAA, and it can have a negative effect there. If you do a QCD, qualified charitable distribution, from your IRA the income is not counted, and it does not affect Social Security or Medicare.
Sharla Jessop 4:28
A lot of people over the years have been saving money for retirement on a tax-deferred basis in their company sponsored 401(k) plan or 403b plan. How is the QCD handled from that?
Jordan Hadfield 4:40
Yeah, this is another very good question. It’s not handled from that. It can’t be handled from that. The only retirement account that qualifies for a QCD is an IRA. So if you have a 401(k) 403b, or 457, these plans do not qualify for a QCD. Now, if you’re retired, and you have these type of accounts, there may be several reasons why you want to consider rolling out of those accounts into an IRA. And we can talk about those in another place. But a QCD is definitely one of them. To move assets from a 401(k) or a 403b or 457 into an IRA is a tax-free rollover. So you can do it without penalty without tax consequence. And then you could use the QCD for your benefit.
Sharla Jessop 5:28
What about Roth IRAs? You know, and Roth IRAs have gained in popularity over the last several years within 401(k)s and just typical Roth IRAs. Can we make a QCD from a Roth IRA?
Jordan Hadfield 5:40
Well, you need to understand that the Roth IRA is tax-free. When you make a contribution into a Roth IRA. It’s all after tax, and that grows tax-free. So when you take a distribution from a Roth IRA, there is no tax due, so there would be no reason to try and complete a QCD from a Roth IRA. It’s only advantageous from a tax-deferred account, tax-deferred IRA that is.
Sharla Jessop 6:00
You know, I think over the last several years QCDs have become more the norm for people who are retired and required to take distributions. And it’s a great way to get money out of the account. But we’ve noticed an unbelievable number of QCDs that have not been reported correctly. And we’ve had many clients who have had to amend taxes.
Jordan Hadfield 6:21
I find this situation even more sad than those who don’t know about the QCD. For those who think they’re getting the tax advantage, and they’re not, that makes me sad. It’s important that we make sure we’re reporting this correctly. And unfortunately, far too often, we see that it’s reported incorrectly, and the benefits are not being taken advantage of. There’s a couple of reasons why I think they’re being reported incorrectly. Unfortunately, there are some people who do taxes who don’t quite understand how to report it, maybe you’re doing your taxes yourself, maybe you’ve got a friend doing and maybe it is your CPA that is just unfamiliar with the QCD. Most financial professionals, most CPAs are familiar with the QCD and how to report it. But sometimes, it is being reported incorrectly. One thing I see often is when the 1099 comes out the tax form 1099, that tells you what distributions have been taken from your IRA. It’ll report the distribution amount. Next to that, it’ll report the taxable amount. And on the 1099, it will often show those numbers exactly the same. However, there’s a little box that says taxable amount not determined. And so when people look okay, I took a distribution of $9,558, and $9,558 is taxable according to my 1099. I just duplicate that on my form 1040. And I’m missing out on the advantage, right, of the QCD. So it’s important to pay attention. That little box is checked that says taxable about not determined. You know, without getting into too much detail about how to file it correctly in this setting, this podcast, because that can be tricky. On your 1040, you’ll often see on line 4a, the amount that’s taken out of the IRA. This is so the IRS can verify that you met your RMD. Box next to it as 4B is the taxable amount. Here, you will put the amount that you took out of an IRA that did not go for a QCD. So for example, someone who takes out a $10,000 IRA donates all $10,000. Line 4a will say $10,000, line 4b taxable amount will say zero, because it’s a QCD no taxes are due. It can be tricky. And for someone who’s not doing taxes often or is a little bit more unfamiliar with how these are done, it’s just, it’s confusing. So my advice to you is to double check with your accountant, if you’re using an accountant, to make sure you’re getting the advantage. You can always come to us. We are happy to look over your taxes and make sure that it’s being reported correctly. Because if it’s not, you’re giving the government money you don’t need to be.
Sharla Jessop 9:02
I think it’s important also for people to understand that we are not CPAs or accountants, and we do not give tax advice. However, tax planning is very important when it comes to financial planning, it’s hand and arm together. They work together. So we can’t give people tax advice, but we can certainly look at their tax return and determine we have some software that helps us determine if it was handled correctly. So if you’re questioning if your QCD was handled correctly, let us know and we can help you figure that out.
Jordan Hadfield 9:32
Yeah, we can help you do the QCD. And we can try and teach you how to report the QCD. But we can’t report it for you. You’re right. We’re not CPAs. And so if there’s a question, reach out to us, we’re happy to talk to your CPA, to make sure that that it’s being reported correctly. You know, another thing we’re doing this year is we’re starting to send out information in January to all of our clients who have reported to QCD with instructions on how to get credit for it. So that’s not something we’ve done in the past, but we’ve seen too many errors. And too many people not, you know, taking advantage of this strategy that should be. And so we’re doing all that we can to educate, and to inform people and to make sure they know how to do it. But you’re right, because we’re not CPAs we can’t do it for you, we can only, you know, educate you and, you know, ask to verify, but we are happy to do that.
Sharla Jessop 10:23
You know, I love tax-free. It’s one of my favorite things. You know, who doesn’t like getting something without having to pay tax on it? And QCDs offer that. When does it make sense to limit that Jordan?
Jordan Hadfield 10:35
Yeah, and this is another great question. Thank you for asking this. You know, I feel like often, we’re shouting about how great a QCD is, right. And we get people excited about, hey, you know, there’s a way that I can save serious money through taxes. And when I say serious money, I, you know, for example, if you have a $10,000 RMD, you’re in the 22%, federal 5% state, that’s $2,700 in taxes you’re gonna pay on a $10,000 distribution. So when I say significant tax savings, I mean, that’s a lot. That’s a lot, right. And so we get excited about that, and we educate people who qualify for these QCDs about it, and we get them excited about it. And sometimes in the excitement, we get people trying to take advantage of the QCD, who probably shouldn’t be. And so let me explain this just a little bit. And I don’t, I don’t want to get too confusing here. But if we take money out of an IRA via QCD, it’s tax-free. But keep in mind, if we have cash in our checking account, that money is also available to us tax-free. Okay, so for clients who don’t need to take a distribution from an IRA, a QCD isn’t as beneficial, it doesn’t help. And that’s because when we remove money from our IRA, there’s an opportunity cost. And that opportunity cost offsets the benefit. Okay, so for those people who don’t need to take a distribution from an IRA, and you want to donate to charity, and you’ve got cash available in a checking or savings account, that isn’t going to, you know, put cash flows at risk. That’s the money that you should be donating is the money in your checking and savings. However, as I mentioned earlier, there is such thing as an RMD, for clients who reached the age of 72, a required minimum distribution, and the government forces you to take money out. So if they’re forcing you to take money out that you don’t need to cover cash flows to cover bills, liabilities, then the QCD is fantastic. Okay. So you know, for example, sometimes I’ll have a client that’s got a $5,000, QCD, they’ve got plenty of cash in the bank, but they want to donate $10,000. In that case, you’re better off to take the $5,000 RMD, and send it to your charity directly as a QCD. And then use the other $5000 from your bank account, as opposed to take all $10 from the IRA. Because, again, that extra five above your RMD there’s an opportunity cost there when you take it out. It’s no longer growing for you long term. You know to answer your question directly, who should benefit? Who should implement a QCD? It’s those people who have an RMD, who are donating to charities, and don’t have money extra above that in a checking or savings account.
Sharla Jessop 13:27
Jordan, I think that’s valuable advice. And I think once people understand QCD, they latch on to it.
Jordan Hadfield 13:33
Right.
Sharla Jessop 13:34
Thanks for sharing today. Appreciate your time.
Jordan Hadfield 13:35
Yeah, thanks for having me.
Shane Thomas 13:36
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn.
The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Lorayne B. Taylor, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
