Done well, charitable giving can make a difference for both the recipient and the donor (often in the form of tax savings). Here are six ways to incorporate charitable giving into your financial plan.
1. Donate cash
Donating cash tends to be the most common way for people to contribute to their favorite charities. However, it’s also the least beneficial from a tax perspective. Thinking beyond cash may help you amplify your contribution as well.
2. Donating stock or other assets
Donating stock (or other securities and assets) may be a more tax effective way to benefit your favorite charity.
With this approach, you might donate a stock that has increased in value since your initial purchase. If you sell the stock, those gains are subject to taxation. While you could donate the proceeds, a more effective approach may be to donate the stock itself to the charity.
When you donate a security, the IRS credits you for the market value of the asset on the day you make the contribution.
3. Donor Advised Funds (DAF)
A donor-advised fund (DAF) can help you benefit your favorite organization, but they can be complex, so it’s important you understand how they work.
1. You open a DAF through a specific 501(c)(3) organization.
2. Once the DAF is open, you can contribute assets (cash or stocks) to the account. Contributions are considered irrevocable, meaning you can’t withdraw or reclaim anything you place into the DAF.
3. DAFs come with investment options. Once you donate assets, they’ll have the potential to grow over time, versus sitting idle in an account.
4. Anything you give to a DAF counts as a charitable contribution on your tax return (assuming you’re itemizing your taxes). These contributions are logged in the year you make them; you don’t need to wait until the funds are released (or used) by the charity to report the donation.
5. Perhaps the biggest benefit of a DAF? You recommend grants to benefit charitable organizations of your choosing.
There’s one “catch” to these approaches. To reap the benefits of a charitable contribution, you must itemize your deductions when you file your tax return. Starting in 2018, the Tax Cut and Jobs Act (TCJA) raised the standard deduction; it may not make sense to itemize your taxes unless those itemized deductions are larger than the standard deduction.
Strategic planning can help you work around this barrier via donation bunching.
What is donation bunching?
With donation bunching, you save your yearly charitable contributions for a few years and donate them all in a single year.
For instance: Say you plan to donate $10,000 a year to charity. That gift can be any asset—cash, security, etc.—and your gift can go to either a registered charity or a donor advised fund.
A $10,000 annual donation may not be enough to push your itemized deductions higher than the standard deduction. But if you set aside $10,000 for the first two years, then bunch those donations with the $10,000 for year three, a $30,000 contribution may create a scenario where itemizing helps minimize your tax bill.
A financial advisor can work with your CPA or tax advisor to create a plan for donation bunching considering your overall financial plan and tax situation.
4. Qualified Charitable Distributions (QCDs)
Sometime in your 70s (depending on when you were born), you must start taking required minimum distributions (RMDs) from any traditional retirement accounts. How much you need to withdraw each year varies.
If you don’t need these payments as income, you may be able to take the money you’re obligated to withdraw from your individual retirement account (IRA) and instead donate that money via a qualified charitable distribution (QCD) , limited to $100,000 annually.
By using your retirement account withdrawals to make qualified distributions to your favorite charity, you’re taking money that would otherwise count as taxable income and putting it toward a cause you value instead. It’s a win for the charity and a win for your taxes. Plus, you can start making QCDs after age 70½; you don’t have to wait until you’re required to start taking RMDs.
5. Charitable Trusts
Charitable trusts are most commonly used to diversify a concentrated stock position, generate a current tax deduction, and benefit a charity. These trusts can be incorporated into estate and legacy planning, since the money can be distributed after you pass.
Charitable lead trust
With a charitable lead trust, your designated charity receives distributions for a set number of years. After that period (say 15 years), any money still in the trust goes back to the owner (you) or your designated beneficiaries (usually children or grandchildren).
Charitable remainder trust
A charitable remainder trust essentially works the other way. The beneficiary (you or your heirs) receives distributions from the trust until the trust period expires. Then, any amount remaining in the trust goes to a pre-selected charity.
Like other trusts, charitable trusts are separate legal entities. They are irrevocable (where you can’t reclaim the assets placed in the trust) and cannot be modified. Giving money to an irrevocable trust removes those funds from your taxable estate, creating an opportunity for long-term tax and estate planning.
Just remember: Trusts are complex legal documents that come with tax, legal, and planning considerations. We recommend speaking with your tax and estate planning attorney, as well as your financial advisor, before establishing a trust.
6. Establish a 501(c)(3)
If you’d like to be heavily involved in a cause, or you want to create a legacy that exists independent of you and your family, you may want to establish a 501(c)(3) nonprofit organization of your own. Out of all the charitable giving opportunities mentioned here, this will involve the most time, effort, and ongoing maintenance.There are two ways to approach this—a private foundation or a general charity. With both, you may solicit donations and amplify your impact beyond your own contributions.
As you might expect, the paperwork can be complex: You must define your mission, form a business entity, file with the IRS, and follow relevant local and federal reporting mandates. We strongly recommend working with a tax attorney, accountant, and other financial professionals to ensure the charity you build reflects your wishes. Once established, your nonprofit should qualify for certain tax exemptions as determined by the IRS.
Interested in Charitable Giving Strategies?
Incorporating charitable giving into your greater financial plan is an effective way to express gratitude, feel more fulfilled, and make a difference in the lives of others. And as a high earner, you have the added opportunity to enjoy some notable tax advantages. To learn more about how we can help you achieve your charitable giving goals, reach out to our team today.
