November is a great month – we get to meet with our loved ones around the Thanksgiving dinner table, ponder what we’re thankful for, and take stock of what’s really important in life. These feelings of self-reflection often inspire us to express our gratitude not just in words but also in action. Whether it be through organizing a food drive or giving back financially, we all feel a bit more connected to our communities near the end of the year. And on a more practical note, the season of giving also presents potential financial advantages.
Giving away a portion of your wealth may end up saving you more money than you think, and the end of the year is one of the best times to take advantage of your goodwill. In this article, we’ll go over methods that you can use to achieve your philanthropic goals and investment objectives in a tax-efficient manner via charitable giving.
Keep in mind, though, that while donating may be uncomplicated, fitting the various donations and tax benefits into your overall investment strategy is much more complex, so it’s essential to consult with a financial advisor and tax professional to determine the most effective and appropriate charitable strategies for you.
What to Donate
Cash
Cash is a straightforward and simple method of donating to a qualified charity of your choice. Charities are likely to receive contributions online, via check, or other convenient methods. Just be sure to keep detailed records, including any communications, donation amounts, dates, and receipts.
Appreciated Assets
As difficult as it is, sometimes we just have to give up winning assets. In fact, offloading appreciated assets, such as mutual funds, ETFs, stocks, and bonds, is one of the core tenets of portfolio rebalancing. And, as you may know, profits usually come with taxes—unless you strategically avoid realizing those profits.
There are a few reasons you may decide to do this besides the obvious and immediate philanthropic purposes.
- By deducting the value of the asset from your taxable income, you are essentially reducing your tax bill while unlocking liquidity—funds that can be redirected however you'd like, such as contributing more to charity or an investment account.
- Selling an appreciated asset typically incurs capital gains tax; however, donating it to charity avoids this tax and still offers a deduction.
- Donating an asset can be part of your portfolio rebalancing strategy. If an asset becomes overrepresented within your portfolio, misaligning your risk profile and asset allocation, rather than selling that asset and paying capital gains tax, you can donate it, claim the deduction, and use the savings to help purchase another asset that will realign your portfolio.
- By diminishing the size of your estate through such charitable donations, you're not only supporting causes you care about but also managing the financial landscape of your estate for the longer term.
- If you converted Traditional assets in a retirement account into Roth, you’ll owe taxes on the amount converted. You can help offset that bill with charitable contributions.
Required Minimum Distributions (RMDs)
Once you reach age 73, the IRS mandates that you start taking Required Minimum Distributions from your retirement accounts, such as 401(k)s and traditional IRAs. These distributions are counted as taxable income and may even push you up a tax bracket. Fortunately, there’s a charitable and tax-savvy way to handle them via Qualified Charitable Distributions.
Rather than withdrawing your RMD and then donating it, you instruct the trustee of your retirement account to conduct a direct transfer from that account to the qualified charity. It’s crucial that this money never goes through your own hands. Then, ask the charity to write you a letter confirming the donation for tax purposes.
How to Donate
Method 1: Donate Directly to Charity
Charities love direct donations, but be sure to keep your receipts and ensure the charity is recognized as a Qualified Charity. You must also opt for itemized deductions rather than the Standard Deduction when tax season comes.
Method 2: Contribute to a Donor-Advised Fund
Transitioning to a more planned giving strategy, establishing a Donor-Advised Fund (DAF) is a method that allows for more flexibility in charitable giving over time. Unlike the immediate donation of an asset, a DAF allows you to make a charitable contribution now, get an immediate tax deduction, and recommend grants from the fund to your favorite charities over time.
What makes DAFs particularly lucrative is that the assets have the potential to grow over time. While this doesn’t have an impact on your own personal finances, as the assets are no longer your property, you still have control over how, to whom, and when you distribute those assets.
Method 3: Donate via Trust
Two types of trusts prove to be valuable regarding both immediate and long-term tax reduction strategies.
Charitable Remainder Trust (CRT):
When you contribute assets to a Charitable Remainder Trust, you’re eligible for an immediate tax deduction based on the present value of the charitable interest (the portion of the trust’s value that is estimated to go to charity) and avoid any capital gains taxation. Once the trust term ends, the remaining assets in the CRT are transferred to the designated charitable organizations.
Charitable Lead Trust (CLT):
Contributing to a Charitable Lead Trust provides a current-year tax deduction, similar to a CRT. The deduction is based on the present value of the income stream that will go to the charity. Just as with a CRT, you can avoid capital gains tax on any donated appreciated assets. In a CLT, the charity receives the income from the trust for a specified term, after which the remaining assets are transferred to your heirs rather than to a charitable organization. This setup allows you to support your chosen charities now while also ensuring your heirs receive the remaining trust assets in the future.
Setting up trusts is complex, requiring expertise from attorneys, financial advisors, and potentially a CPA, and taking several weeks to months. So, if you intend to establish one of the aforementioned trusts by the end of the year, you’ll need to begin as soon as possible. However, once they are established, you can start integrating your contributions into your overall financial plan on a yearly basis.
In Conclusion
Beyond the philanthropic aspect of charity, strategic charitable giving can also play a vital role in tax-efficient financial planning. From straightforward cash donations to more sophisticated methods like appreciated assets and trusts, there are multiple ways to integrate your goodwill into your investment strategy.
Nevertheless, the complicated nature of taxes and donations requires careful planning by a professional or perhaps even a team of professionals.
Ready to maximize your charitable contributions this season? Click the button below, and let’s start planning together.
