By Travis G. Bezella
Travis G. Bezella, MBA, CFP®
“Tis the season” as they say and many Americans are looking over their list of charitable causes this time of year to consider what non-profits they want to support. About 70% of charitable giving is done by private individuals and upwards of 25% of total giving is done between Thanksgiving and New Year’s.
This year however, there is a twist for most Americans and you’ll want to make sure you utilize the new tax rules to maximize your gift.
The new tax reform for 2018 increased the standard deduction and eliminated some itemized deductions which is expected to reduce the number of taxpayers that itemize by more than 50%, mostly among the middle class. For many, the 2018 tax reform means less tax benefits for giving, but there are still some tax benefits available.
One easy way to give is by utilizing your IRA. For folks that are subject to Required Minimum Distributions (RMDs), you can give directly from your IRA to a charity (RMDs are for those that have reached age 70.5 and have retirement accounts). You don’t get a deduction but you don’t have to pay the income tax on the distribution either, making this strategy perfect for a retiree who may no longer itemize under the new tax code.
The mechanics of this can be tricky as the distribution needs to be payable directly to the charity. Most brokerages have paperwork where you can direct distributions to a third party, so for larger distributions this is the route to go. However, you may have several charities that you want to support in smaller increments and requesting paperwork for $25 or $100 donations and tracking these gifts across a dozen or so non-profits might not practical. In this situation, it is best to request a checkbook specifically for your IRA account. Most brokerages offer this feature which will allow you to write smaller checks to as many charities as you want in the same way that you were probably making the donations to be begin with, by writing them a check.
By writing the check from your IRA, you satisfy the RMD and avoid the income tax on the distribution. You just need to make sure that the check is cashed by the charity before year-end. If it doesn’t clear your IRA by December 31st, it doesn’t count as part of your RMD, so write your checks early and make sure they clear. Remember, any amounts not distributed that should have been distributed as a part of your RMD carry a 50% tax penalty.
Another way to give utilizing your IRA is by naming a charity the beneficiary. You don’t get income tax benefits today, but this could make sense given your overall plan. There are a couple situations where this is attractive.
First, if you’ve incorporated bequests to charities as a part of your Will or Trust. Some folks want their assets distributed to individuals as well as charities when they are gone, but they haven’t taken into account what assets are best to allocate between the two. If you direct your IRA to be paid directly to a charity at your passing, those funds go to the charity income tax free. Charities don’t pay income taxes but individuals do. If you name an individual as a beneficiary, they will have to pay income taxes on any distributions that are made from the IRA to them.
Consider this simple example: Jerry has $75,000 in his IRA and $500,000 in his investment account. He has a Will that directs $75,000 to his church and the rest is to go to his daughter Sally when he passes. Like most people do in this situation, Jerry has his daughter named as the beneficiary of his IRA.
Under this scenario, when Jerry passes, the full $75,000 IRA is paid to Sally, $75,000 of the taxable brokerage account is given to the church with the remaining $425,000 going to Sally. Depending on what Sally’s tax bracket is and what state she lives in (I happen to live in the high tax state of Minnesota which takes another chunk), a third or more of this could go to taxes. At the end of the day, $75,000 goes to the church, $475,000 goes to Sally and $25,000 goes to the IRS.
On the other hand, Jerry could have named his local church the 100% beneficiary of the IRA fulfilling his desire to give $75,000 to his church and given his investment account to Sally. In this situation, the tax haircut is avoided on the $75,000 which would have left $25,000 more to Sally compared to the above example. After all, it probably wasn’t Jerry’s intention to name the IRS in his Will, but that is effectively what is happening if the planning isn’t done correctly.
Second, the mechanics work nicely for changes using your IRA as your charitable gift at your passing versus naming the charity in your Will. If you name charities in your Will and those charities ever wind down or you want to change your eventual gift to another charity, you’ll need to modify your documents. You’ll need to hire an attorney and create a codicil to your Will or an amendment to your Trust which can be expensive (not sure if it is best to give to attorney’s or include the IRS like the example above, I’ll let you decide).
Alternatively, you could name the charity as the beneficiary of your IRA. You can name as many charities as you like and beneficiary designations are easy to update. You just request a form from the custodian of your retirement account and you can list as many as you want in whatever percentage you want. There are no costs for doing this, so feel free to change this as much as you want.
Another important point you’ll want to keep in mind: beneficiary designations should be coordinated with your Will or Trust. This is because beneficiary designations will overrule your Will or Trust; these legal documents won’t automatically take into account the beneficiaries you’ve listed on your IRA and vice versa. If you name the local church as beneficiary of your IRA and name the Red Cross in your legal documents, both charities will receive part of your estate. It is critical to make sure your beneficiary designations work in the context of your overall estate plan, something that I see missed more often than not.
There are other ways to give outside of your retirement accounts and you might be familiar with them. One way is to give appreciated securities which allows you to avoid the taxes due if you were to sell the stock and send a charity a check. Most non-profits will have a brokerage account set up to receive gifts like this as it is a pretty routine way to give. When the charity sells the stock and realizes the taxable gain, they won’t have to pay capital gains tax as non-profits don’t pay taxes.
You usually want to donate stocks that have appreciated the most because the tax benefit of giving this way is avoiding the capital gains tax. A lot of times, this means donating the stock you are most fond of because it was the pick that paid off the best. Don’t worry, you can purchase the same dollar amount you donated using the cash you were originally going to send to the charity. This will effectively increase your overall cost basis and reduce your capital gains exposure. You may even take this opportunity to buy something else and diversify your holdings.
You can also utilize a donor advised fund to receive stock contributions if you want the tax benefit of donating today but plan on making the gifts in future years. With a donor advised fund, you get the tax benefit when the funds get contributed to the fund and you then choose when they are directed to charities. A common strategy is to bunch your charitable gifts for several years into just one year. This works for folks that will itemize if they make a large gift one year, but wouldn’t if those gifts were spread across several years. Give to the donor advised fund in year one, get the deduction in that year by itemizing and then in years two, three and four, direct funds out of the donor advised fund. In years one, you’ll itemize your tax deductions and in years two through four you’ll use the standard deduction, but will have levelized your giving across all years.
You can also use the donor advised fund by naming it as the beneficiary of your IRA. By doing this, the donor advised fund can receive the IRA funds free of income tax eliminating the IRS as a beneficiary of your estate plan. You can name your kids as the successor advisor of the fund and now the kids get to continue your tradition of giving.
At the end of the day, there are still a variety of ways to make charitable gifts with varying levels of tax benefit. Figuring out the optimal strategy depends on your unique situation and long-term goals. To determine the right strategy for you, you’ll want to have the perspective of an estate planning attorney, financial planner, CPA, etc. You’ll also want to review your plan as tax and estate laws change or when your situation or goals change. Having a team of specialists is a must for developing the strategy and monitoring it on an ongoing basis.
This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.