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.
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.
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.
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.
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.
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.
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.
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.
Nevertheless, the complicated nature of taxes and donations requires careful planning by a professional or perhaps even a team of professionals.
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