Generous Giving in Financial Planning
By Pamela A. Martin, AIF®
June 7, 2019
This past month, I had the distinct honor of witnessing the most precious moment in my career as a financial advisor. You see, as a financial advisor, we are called upon during many stages of life; the ups and downs, the mountains and the valleys. It is during the lows that our advice, service and support is most frequently sought– death, illness, divorce, job loss, financial mishaps – and we feel privileged to be able to help in those sensitive situations of critical importance to our clients. It is special for us also to be contacted by clients in connection with the highs – births, marriage, retirement, home purchases, college bound children and grandchildren. Unfortunately (though understandably) for the financial advisor, these mountain tops are often relayed after the fact and we miss the initial excitement. This past month, I was able to be a first hand witness to one of these mountain tops with a client. I’ll call her Jane.
Jane arrived at the office for her annual review. She had questions about the economy. We went through her portfolio and discussed changes to be made in the future. Life circumstances were shared and then it happened. Her face beamed as she said, “Let’s spend that RMD.” Jane was in a place in life in which all her expenses were covered by pension and social security. She was required to withdraw a minimum amount from her IRA each year - so called RMDs. With a broad smile and a few giggles along the way, Jane proceeded to list 12 charities to which to send charitable contributions. Watching as this lovely woman giggled like a school girl and said more than once, “This is so fun!” was a bright spot in my month.
Creative ways in which to expand generosity is one aspect of financial planning which can be overlooked by many the financial planning client. So, you’re asking yourself, does generous giving have a place in my financial plan? Great question. Let’s explore a couple of giving options available.
Qualified Charitable Distribution from IRA
Transferring funds from your IRA directly to a charity constitutes a tax-free transfer. By sending the funds directly to the charity, the RMD amount is not added to your Adjusted Gross Income (AGI), thus preventing an increase in social security taxation and possible Medicare surcharge. Less taxes for you;, more money for the charity. The allowable amount you may contribute currently through the tax-free transfer is $100,000 per year and can exceed the amount of your RMD. The option for tax-free transfer must come from an IRA as 401K accounts do not allow for this type of distribution.
The process for this type of distribution is not complicated and simply requires a form or two. The check is sent directly to the charity from your IRA account. This allows the custodian to verify it is a charitable donation and provide the appropriate tax documents. You will want to notify the charity to expect the donation so as to receive the appropriate tax documents from them. With the increase in the standard tax deduction, you may even see a simplified tax filing as the need to itemize deductions is decreased. Donations made through a tax-free transfer have a greater benefit on the charity than having the RMD distributed to your checking account and then writing a check to the charity. It’s a win-win situation.
Donor Advised Fund
While giving directly from your IRA to a charity is tax effective, what if you could expand that tax effectiveness by lumping several years’ worth of giving into one year and receive a tax break even prior to 70 ½? The donor advised fund (DAF) is an irrevocable trust agreement in which the donor, you, makes gifts directly to the sponsoring charity that maintains the DAF and then recommends the charities to which grants from the balance in such DAF are to be made. While the tax deduction is claimed in the tax return for the year during which any gift to the DAF was made, the grants to charities from the DAF often are ongoing for years. The ability to make grant recommendations continues for the life of the donor and then future generations can be appointed to make recommendations for the rest of their lives.
Here is an example of how this could work. Say you donate $10,000 to charities every year and you plan to do so for the next 5 years. You can contribute $50,000 to your DAF this year and recommend that the DAF make $10,000 grants each of the following years. By contributing the $50,000 in one year, you have increased your itemized deductions and reduced your tax liability for that year. You are not increasing the aggregate amount of the charitable deduction ($50,000 either way), but you are accelerating the timing of the deduction. The acceleration of your deductions can be especially beneficial if your marginal tax rate is higher now than your expected marginal tax rate in future years (for example, if your marginal tax rate in this year is 35% but it is expected to drop to 20% starting next year, accelerating your deduction would increase the value of the charitable deduction by $5,000 (the result of $40,000 times the 15% difference in marginal tax rates). The DAF can then be replenished and the tax break again received. The maximum tax deduction currently allowed for charitable donations is 60% of AGI, up from 50% in 2017.
One of the byproducts of using a DAF is the satisfaction that many donors feel when making an immediate gift of a large amount. They often are overcome by a deserved sense of accomplishment and pride over their large immediate gift. Clients often also comment about the good feeling they experience when they see how accelerating their gift substantially stretches the aggregate amount of their grants. This happens because the amount of their gift to the DAF is invested. Let me elaborate through the use of the above example. Imagine that the $50,000 initial gift is invested and that the annual return of the amount in the DAF is 7%. At the end of year one, the balance would be $53,500 ($50,000 plus $3,500). Then, the DAF would make the first grant of $10,000, meaning that $43,500 would remain invested in the DAF. At the end of year two, the balance would be $46,545 ($43,500 plus $3,045). Then, the DAF would make the second grant of $10,000, meaning that $36,545 would remain invested in the DAF. After six annual grants of $10,000, there would still be $3,500 in the DAF, meaning that a $50,000 gift ends up resulting in $63,503.61 of grants.
A DAF is also a beautiful means to include multiple generations in giving. The DAF can be funded by multiple individuals and generations. Imagine the fun and unity to be found in sharing your heart to your children and grandchildren as you explain your chosen charities and your passion for the charities’ missions. Sharing and involvement in this way can bring a family together and increase the likelihood that future generations will carry-on your generosity. Is there a better gift we can give future generations than the gift of generosity?
Donating of Appreciated Stock
Were you one of the early investors in Apple or Netflix? If so, you may have a sizable tax bill coming when you sell the position. But what if you could further your favorite charity and avoid that tax bill? Giving of appreciated stock may be the ticket. Regardless of your cost basis on the position, you, the donor, are deemed to have gifted the stock at the appreciated market value for tax deduction purposes. The possible adverse tax implications of selling the position are eliminated. The charity also never has to worry about the tax bill due to their charitable status. This strategy can also create a better balance in an over-weighted portfolio, allowing for greater diversification. Can you say win-win again?
While tax deductions are not the primary reason for giving to charity, providing the greatest value and impact to the charity probably is. If you are intrigued about stretching the amounts of your gifts to charity, doing so while saving more than you would without a DAF, or some of the other softer but no less important benefits mentioned above, such as passing on your values of generosity or philanthropy to your family, your financial advisor is here to help you every step of the way. Each and every circumstance is different. The strategies above are not all-inclusive and may be used in various combinations to bring about the greatest overall impact for both you and the charity. I recommend bringing your financial advisor into the fun of planning your next charitable donation. Not only are we likely to provide significant value, but we will experience much fulfillment, helping our clients’ implement their charitable “highs.” A win-win-win for the client, the charity and us.
Unless otherwise expressly indicated, the opinions or views expressed in this article are the author's own and do not reflect, and may differ from, the opinions or views of Strategic Financial Group, LLC or others within Strategic Financial Group, LLC, including its officers, managers, owners, employees or other service providers.