This time of year, people’s thoughts often turn to ways they can help others. From volunteering at food banks to caroling in assisted living facilities, the ways you can brighten the season for others are limitless. A particularly effective way to help spread joy during the holiday season is through charitable giving.
For many, charitable giving during the holidays involves putting money in Salvation Army kettles and perhaps writing a check or two to their favorite causes. However, there are many ways to give financially, and many more ways to add value to those gifts.
As the value of your donations increases, properly structuring your giving becomes increasingly important. For example, if you’re a retiree in the 22% income tax bracket who wants to give $5,000 to a charity, without properly structuring the donation, you might actually spend more than $6,000 to do so! That’s due to a common step many generous retirees overlook: the qualified charitable donation, or QCD.
Skip the bank account
A QCD is a financial gift made to an organization directly from an IRA. Available to people age 70½ and older, QCDs have several advantages over simply writing a check.
To give money in the traditional manner, you withdraw money, put it in your bank account, then write a check or make your donation online. If that withdrawal comes from a tax-deferred account like an IRA, it counts as income, and you will have to pay taxes on it. However, if you instead donate the money using a QCD, the money gets transferred directly from your IRA to the charity. By skipping your bank account the funds are withdrawn from your IRA tax-free, saving you money.
That’s not the only advantage of using QCDs to donate money: QCD distributions from your retirement accounts count toward the required minimum distributions (RMDs) you must take from tax-deferred accounts every year once you reach the required age. Many retirees find themselves taking distributions they don’t need because the IRS insists they do so; after being taxed on withdrawal, that money just languishes in a bank account, having reduced their retirement nest egg by more than the face value of the money! A QCD will reduce the amount of money you are forced to withdraw — and pay taxes on.
Stacks save
Most people know charitable donations are tax-deductible. However, most don't donate enough in a single year to take advantage of the tax deduction. The federal standard deduction for taxes in 2023 is $13,850 for single filers and $27,700 for joint filers. If your itemized deductions don’t exceed the standard deduction, you won’t get a tax deduction for your charitable donations, unless you stack them.
Consider a single person who donates $5,000 to charity every year. After three years, that’s $15,000. If that person were to donate $15,000 in a single year, they’d get a tax deduction for it. But upping your charitable donations by 300% per year may not be affordable — even $15,000 every three years already is substantial. That’s the purpose of stacking: By setting up a donor-advised fund, or DAF, you can donate a large amount of money in one tax year, then direct how and when that money is given to charity. By donating $15,000, then directing $5,000 per year be distributed, you end up with the same result from a giving standpoint, but you also get to take advantage of a tax deduction that wouldn’t otherwise be available to you.
QCDs and DAFs are simple, easy ways to maximize the power of your donations while minimizing the tax burden, but they’re really only effective for regular monetary giving. If you wish to donate other types of assets, such as real estate, highly appreciated stock or very large amounts of money, you could consider charitable trusts, of which there are several varieties.
How a CRT works
One of the most common is the charitable remainder trust, or CRT. Assets donated to a CRT are tax deductible upon donation. The trust can then pay you or a designated beneficiary a cash flow from the assets within the trust. When you pass away, the remainder of the assets within the trust go to the organization of your choice.
In a CRT, the cash flow comes from both the assets within the trust and income generated by them. If the assets include rental property, the cash flow can be paid out of the rental income generated, or by selling assets, or both.
If you want to ensure the principal of the trust remains intact, you can instead set up a pooled income fund (PIF): The cash flow is then paid only by the income investments generate, such as dividends and interest. The principal can’t be touched; this means you may receive less income while still living, but there will be more principal available to the charity when you pass away.
Unlike CRTs, PIFs can be multigenerational; you can set up an income stream for yourself, then your descendants. Only after your children pass away will the trust disburse to your chosen charity.
Because PIFs have such a long lifespan — sometimes more than half a century — it’s important to choose a beneficiary that’s likely to still be around when the payout event happens. This is why institutions such as well-established colleges are common beneficiaries for PIFs.
The bottom line is, a lot of generous people are voluntarily paying more in taxes than they need to in order to help worthy causes. By exploring donation alternatives, you could reduce your tax burden while increasing the effectiveness of your giving.
