While most people we know would love a respite from the news these days, it’s hard to shut it off. Despite the uncertainty in our world and the media, your financial situation never stands still and it’s important to remain proactive.
With that in mind, there are things you can do that save you money, and if you’re able, allow you to support a cause you find meaningful. Giving to charity while simultaneously lowering your tax burden can be a win-win. Not only is donating undeniably great for the recipient, studies have shown that it’s also good for your physical and emotional well-being.
Here are some tips that may help you lower your tax burden and participate in charitable giving.
What is a charitable tax deduction?
Itemizing your deductions can reduce your taxable income. An itemized deduction is a donation or expenditure toward an eligible product, service, or organization that can be subtracted from your adjusted gross income (AGI) to lower your tax bill. You should consider itemizing (claiming) your deductions when their total amount surpasses the amount of the standard IRS deduction, which for 2021 is $12,550 for individual filers, and $25,100 for married couples filing jointly. (Speak to your advisor and CPA before using this strategy.)
What are some approaches you might take that could lower your tax burden?
Donate your required minimum distributions (RMD) from your IRA directly to a charity. Sometimes people don’t realize that waiting until they are forced to start taking RMDs might not be the best strategy.
Yes, it feels great to have that money stashed away, out of sight, growing free from taxation year after year, but when you turn 72 (or 70½ if before 2020) and your RMD (which is based on a complex formula that considers your retirement account balance and your life expectancy) is so large, it bumps you into a higher tax bracket. Tax planning is so important because the first rule of donating distributions from a retirement account such as an IRA is to not make any errors.
Whether you are already taking RMDs from your IRA, or you’re going to begin soon, one potent tax-saving maneuver is to donate a portion (or even all) of it to charity, called a qualified charitable distribution (QCD). You can lower your tax burden by donating up to $100,000 a year or $200,000 for couples. While not the same as an itemized write-off, this should reduce your adjusted gross income, making it the same as if you had received a deduction.
The types of accounts that are almost always eligible for QCDs are traditional IRAs, SEPs, and simple IRAs. But remember, mistakes are costly, and the IRS doesn’t have a sense of humor.
For instance, unlike an IRA, you can’t donate your RMD from a 401(k) until you’ve rolled that money over into an IRA. Otherwise, you’ll trigger a tax bill. Also, you can’t take an RMD and then later donate that money and then receive the same tax benefits. Besides other penalties and drawbacks, this might impact how much your Social Security is taxed.
So, how much can you save?
Essentially, you are saving your tax rate. As an example, your RMD is $10,000 and you donate half of it to charity. This $5,000 donation doesn’t count as taxable income, so you pay no taxes on it. Assuming a 22% tax rate, you save $1,100 in taxes.
What about donor-advised funds?
Called “The Waiting Room for Charitable Donations,” a donor-advised fund (DAF) is a charitable giving mechanism established by a public charity. It’s something like a charitable investment account, whereupon your stored assets are invested, and later donated. In this scenario, you get an immediate tax deduction, the funds grow tax-free, and then later you can direct those funds to a qualified charity of your choosing.
While their immediacy and flexibility mean that DAFs are getting ever more popular (from 2017 to 2018, the number of DAFs grew by 55%), they have pros and cons. On the plus side for instance, besides the tax deduction, you can take your time and decide which charities you want to support. The fact is that DAFs can be terrific for people who have experienced a windfall (say, after selling a business) that is going to increase their tax exposure.
On the downside, some critics assert that DAFs may keep non-profits from building personal relationships with donors, because donor information is not always available to the charity. Conversely, it’s difficult to assume that the money would automatically be available to the charity were it not for the tax advantages of the DAF to the donor.
Your Next Steps
Because hanging on to as much of your hard-earned savings as possible takes a plan, always speak to your advisor and CPA before undertaking any new tax strategy.
While forward-thinking tax planning should be an important part of every person’s short- and long-term approaches to money, the entirety of your situation needs to be examined for your financial professionals to know exactly which strategies you should pursue.
You may request a free financial consultation at raa.com/advisor-call to learn how the team at RAA can help.