For many wealthy individuals, giving to charity is gift enough in itself. They may not be aware that their goodwill can also contribute toward retirement
Direct giving or donations through IRAs, charitable trusts, or other models can be an excellent way to enjoy tax deductions and the contentment of helping others through a qualifying organization of your choice. Here are a few methods of doing it:
A direct charitable gift is the simplest mechanism
Donors can choose to directly give money or property to organizations, and certain gifts to qualified organizations are of course deductible from the donor’s taxes. The IRS regards gifts to the following organizations as eligible for a tax deduction:
- “A state or United States possession (or political subdivision thereof), or the United States or the District of Columbia, if made exclusively for public purposes;”
- “A community chest, corporation, trust, fund, or foundation, organized or created in the United States or its possessions, or under the laws of the United States, any state, the District of Columbia or any possession of the United States, and organized and operated exclusively for charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals;”
- “A church, synagogue, or other religious organization;”
- “A war veterans’ organization or its post, auxiliary, trust, or foundation organized in the United States or its possessions;”
- “A nonprofit volunteer fire company;”
- “A civil defense organization created under federal, state, or local law (this includes unreimbursed expenses of civil defense volunteers that are directly connected with and solely attributable to their volunteer services);”
- “A domestic fraternal society, operating under the lodge system, but only if the contribution is to be used exclusively for charitable purposes;”
- “A nonprofit cemetery company if the funds are irrevocably dedicated to the perpetual care of the cemetery as a whole and not a particular lot or mausoleum crypt.”
If deductions are itemized, an individual taxpayer “may deduct up to 50 percent of [their] adjusted gross income, but 20 percent and 30 percent limitations apply in some cases. Tax Exempt Organization Search uses deductibility status codes to identify these limitations.”
IRAs and charitable giving
The required minimum distributions (RMD) from an IRA plan must by law be taken out when reaching age 70.5 or upon retirement. Failure to do so could mean paying a 50 percent excise tax. Tax can be doubly avoided by not only taking the RMD but by donating it to charity. This way, no taxes will be owed on the RMD, leading to more savings.
Alternatively, the charity itself may be named the beneficiary of the IRA. This will allow them to receive the gift tax-free while also qualifying the donor for charitable deduction.
Beyond direct charitable gifts and IRAs, however, there are several more-complex strategies for tax advantaged charitable giving:
Charitable remainder annuity trusts (CRATs)
Establishing a CRAT sees a donor select their charity/charities of choice to be the ultimate beneficiary of the trust. The donor then places assets into that trust which are irrevocable. This “locked in” approach may deter some, but it also means that no taxes will be owed on any gains. The amount of income received from a CRAT is fixed and guaranteed regardless of market performance
During the donor’s lifetime, the CRAT pays a fixed sum annually to a beneficiary other than the charity. This may be the donor themselves or another designated party/parties. The annuity is a percentage of the overall value of the CRAT—no less than 5 percent and no more than 50 percent of the trust’s initial fair net market value.
The timespan is flexible. CRATs may last until death or for a set number of years. Donors choosing the latter only have one option under IRS rules: it must be 20 years. If the former is chosen, when the donor or their designated beneficiary/beneficiaries pass away, any funds remaining in the CRAT go to the charity. The sum remaining in the trust at time of charitable transfer must be no less than 10 percent of the initial amount.
The CRAT itself is tax-exempt, but the annuity paid likely won’t be. The exact tax outcome here varies. Charitable contributions make donors eligible for an income tax charitable deduction which can mean tens of thousands of dollars toward retirement planning. A trust can also minimize or even reduce estate tax while the transfer of appreciated assets typically won’t incur any immediate capital gains tax.
Charitable remainder unitrusts (CRUTs)
A CRUT operates in a very similar manner to a CRAT, with the exception that the annuity is more fluid. It still cannot be less than 5 percent or more than 50 percent but this time, the annuity is calculated every year based on the current fair market value of the assets, requiring the trustee to annually determine what the payout will be based on this.
Charitable lead trusts (CLTs) and Charitable Lead Annuity Trusts (CLATs)
CLTs are something of a reversal of the CRAT/CRUT model. Charities receive income throughout the CLT’s existence while the non-charitable beneficiaries receive what’s left over when the trust term ends. CLATs pay a fixed amount to charity but are created for the ultimate benefit of the non-charitable beneficiary, who receives the remainder of the trust at term’s end as well as any asset appreciation over time.
Donor-Advised Funds (DAFs)
DAFs offer several tax benefits while benefitting charities. Tax deductions are immediate when contributing to a DAF. They’re not subject to estate tax, there’s no capital gains tax on gifts of appreciated assets, and any investments will appreciate tax-free. Income tax deductions can be significant—up to 60 percent of adjusted gross income for a cash donation and up to 30 percent for real estate or appreciated assets such as securities which have been held for more than a year.
DAFs are offered by third-parties and are closely regulated by the IRS to avoid any abuse. Legitimate organizations will professionally manage a donor’s charitable assets at a cost far below that charged by some private foundations, creating another opportunity to save. Additionally, the name of these funds comes from the donor being able to advise the charity on how best to use their donation.
These are only a selection of ways that charitable giving can save on taxes and contribute to retirement planning. For more information on planning your financial future, get in touch with us at the details below.
Lindberg & Ripple offer customized wealth management, investment and insurance solutions to wealthy families and successful businesses. We help our clients craft a comprehensive wealth planning model to achieve their financial goals with minimum fuss and maximum savings. To learn more connect with us at our Connecticut or Florida offices or complete our contact form.