The Tax Benefits of Giving

With fall décor already lining the shelves, it feels like the season of giving is right around the corner. As you consider your gifts and donations this year, keep in mind the potential tax benefits that charitable donations can offer, making your generosity even more rewarding.

This article outlines the tax advantages of charitable giving and provides ideas to help you make the most of your donations.

Turning RMDs into Tax Savings with a Qualified Charitable Distribution

If you are 70½ and older, making a qualified charitable distribution (QCD) could be a valuable tax-saving strategy for IRA owners. Individuals can donate up to $105,000 directly from a taxable IRA to one or more charities tax-free each year. Married couples can effectively double the limit by each contributing $105,000 to a qualified charity, helping to reduce overall tax liability.

The real advantage of QCDs is when required minimum distributions (RMDs) kick in at age 73. Those who know they need to make withdrawals from their retirement account can choose to make a QCD and have it count toward the required amount to be distributed. This not only fulfills the RMD obligation and avoids income tax, but it also helps prevent being pushed into a higher tax bracket, triggering higher taxes on Social Security income, higher Medicare premiums, or experiencing income phaseouts of certain tax deductions.

Charities eligible for a QCD are IRS-approved 501(c)(3) tax-exempt organizations. QCDs can be made to multiple charities of your choice. Unfortunately, donor-advised funds, private foundations, 529 plans, and tuition payments to nonprofit organizations do not qualify for the tax-free distribution.

To calculate your estimated RMD, enter your IRA account balance and age into the Required Minimum Distribution Calculator and evaluate its impact on your overall income. This exercise will help you assess your overall tax liability and determine if you need to take steps to manage your tax burden, such as making a QCD.

The donation must be made directly from your IRA to the charity to qualify, so you will have to contact your IRA administrator to initiate the donation.

Unlocking Lifetime Payments with Charitable Gift Annuities

Thanks to the Secure 2.0 Act of December 2022, individuals now have the option to support a charitable cause by funding a charitable gift annuity from their IRA accounting using a QCD. This new law precipitates additional opportunities for retirees who are looking to defer their tax obligations, satisfy RMDs, and support a good cause.

A charitable gift annuity is a lifelong agreement between a donor and a qualified charitable organization. In exchange for a once-in-a-lifetime donation, the charity provides a guaranteed stream of income for the donor’s (or beneficiary) lifetime. Income is calculated based on the age of the donor, life expectancy, and the number of beneficiaries. The American Council on Gift Annuities suggests rates between 5% and 9.7%. Once the donor(s) passes away, the remaining assets of the annuity revert to the charity.

How it works: Eligible donors aged 70½ or older can make a one-time election of up to $53,000 ($106,000 for married couples filing jointly) in a single year toward a charitable gift annuity, which counts towards the above mentioned $105,000 ($210,00 for married couples filing jointly) annual limit for direct IRA distributions to qualified charities. The total contribution can be divided into smaller payments made over the course of the year and can be used to fund more than one nonprofit.

The tax treatment of charitable gift annuities follows the same rules as funding a QCD to a 501(c)(3) organization—the distribution is not treated as income since it is made directly to the charity, and it does typically fulfill RMD requirements. However, the annuity income from the charity is taxable.

In addition to charitable gift annuities, individuals also have the option to employ the same strategy to a charitable remainder trust (CRTs), where distributions are routed into a trust and the trust administers the donation to a charity and pays income. A CRT can take the form of either a Charitable Remainder Annuity Trust (CRAT), which provides a set annual income, or a Charitable Remainder Unitrust (CRUT), which pays out a fixed percentage of the trust's current value each year.

While the term “legacy IRA” isn’t officially recognized in tax law, many industry professionals use it to describe this overarching strategy involving transferring funds from a traditional IRA to a financial instrument to maximize tax-smart benefits and pay income for life. Over the last couple of years, legacy IRAs have picked up steam as interest rates climb. With higher rates, the fixed payments from new contracts also increase, resulting in their growing appeal.

Donating Stock to Save on Capital Gains Tax

Although cash donations offer several tax benefits, donating publicly traded stock is one of the most tax-savvy ways to give. Why? It’s twofold: The gift is not only tax deductible at full fair-market value but there’s also no capital gains tax to pay if the security has been held for over a year. This means that donating appreciated stocks can result in a charitable donation of up to 20 percent larger than a cash donation due to the avoidance of capital gains tax, which can significantly add up over time.

Investors often have stocks they’re committed to holding for the long term, especially as their value appreciates. However, the growth in the value also means potential hefty capital gains taxes down the line. Whether in an effort to rebalance a portfolio or reduce tax liability, donating stock comes with valuable tax benefits to consider as an alternative to cash.

Sealing the Deal with a Donation Acknowledgement Letter

The IRS requires nonprofits to provide donors with a contemporaneous written letter of acknowledgement to substantiate a charitable contribution of $250 or more. This serves as proof of the contribution and helps to ensure the integrity of charitable giving. Be sure to keep this acknowledgement letter, along with a record of the transaction, whether it be a receipt, canceled check, or other form of documentation. If donating stock, you need to have documentation showing its value at the time of the donation as the charity is unable to provide this. These documents will be used to validate the contributions when claiming the corresponding tax deductions during filing season.

Next Steps

If you’re approaching or already in retirement, discuss the potential benefits of charitable giving strategies with your advisor. From IRA-funded QCDs and legacy IRAs to stock donations, there is a tapestry of strategies to consider for your retirement planning and philanthropic goals. To learn more and review your options, contact your R&A advisor.