There are a number of charitable giving strategies that can be more efficient than writing a check. One of them is gifting financial assets such as mutual funds, stocks, exchange-traded funds, etc. Since these assets have not been liquidated, the money hasn’t been taxed and the funds aren’t worth the full 100 cents on the dollar.
Every situation is different and should be reviewed by a financial advisor. For this writing, we are going to look at charitable giving strategies for people age 70.5 and older and people younger than 70.5.
Age 70.5 and Older
Qualified Charitable Distribution (QCD) from an IRA
For thoseage 70.5 and older, the most effective charitable giving strategy is usually through pre-tax traditional IRA assets (not Roth IRAs). IRA funds can be given directly to a charity and donors can avoid paying income tax on those funds. In effect, the IRA isn’t worth 100 cents on the dollar because of the tax bill on distributions. It is not uncommon to see IRA funds worth only 60 cents on the dollar due to high taxes assessed at ordinary income tax rates. Donating directly from the IRA allows donors to use 100% of the value for charitable purposes. The tax law permits each person who has attained age 70.5 to give up to $100,000 annually from the IRA. Thus, a married couple could give $200,000 annually, assuming they’re both age 70.5 and older.
This has become a valuable strategy because of the new higher standard deduction, which has caused fewer taxpayers to itemize expenses and take charitable contribution deductions. Donors do not receive charitable income tax deductions for this strategy since they avoided paying income tax on the money from the IRA. However, QCDs lower the amount of modified adjusted gross income and possibly help taxpayers avoid Medicare premium increases as well. QCDs also help satisfy the annual Required Minimum Distribution (RMD) requirement.
This strategy works only for IRA assets. If you’re age 70.5 and only have a 401(k) balance, you’ll first have to roll that money to an IRA. Also, make sure to notify your tax preparer. IRA custodians are not required to identify these transactions as a QCD on the Form 1099-R and they may be characterized as an RMD.
Younger than Age 70.5
Donor Advised Funds (DAFs)
Those who are younger than 70.5 should give serious consideration to DAFs. These are offered by various community foundations and select mutual fund companies. They are appealing because people can transfer mutual funds, exchange-traded funds, stocks and certain other assets to the DAF and avoid taxes on the gains. This means donors can use 100% of the value for charitable purposes.
To illustrate, let’s assume you decide to give a charity $10,000 annually for the next three years. You establish a DAF and then select the stock or fund you’d like to transfer into it (ideally positions with the lowest cost basis and highest tax burden). This transfer doesn’t require you to pay any taxes. Once in the DAF, the funds are liquidated free of income taxes and then distributed to the charity over the three-year period. In the meantime, the liquidated positions are reinvested inside the DAF to continue earning a return on the assets. You get to use 100% of the gifted asset’s value. If you want to replace the gifted asset, you can purchase the fund / stock and thereby establish a cost basis higher than the gifted asset.
In addition to the aforementioned tax benefits, DAFs qualify for charitable income tax deductions. Donors can also time their DAF contributions to maximize allowable tax deductions. We do see “bunching” where individuals transfer three to four years of expected charitable gifts in just one year. This allows them to get above the new standardized exemption limit of $10,000 annually.
It has been said that you can make more money through tax savings than by making more money! Using tax-burdened assets to satisfy charitable gifting effectively reduces the family “cost” of making the gift. Donors should discuss these charitable giving strategies with their tax advisors and confirm the best options for their individual situations. The wealth management professionals at SilverStone Asset Management are also here to help!
This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, tax advisor or plan provider. Pursuant to IRS Circular 230, SilverStone Group notifies you as follows: The information contained in this document is not intended to and cannot be used by anyone to avoid IRS penalties.
This article originally appeared in the 2019 | ISSUE ONE of the SilverLink magazine, under the title “Charitable Giving Strategies | Stop Writing Checks!” To receive a complimentary subscription to the SilverLink magazine, sign up here.