How Charitable Giving Actually Saves You Money

Charitable Giving

At this time of year, clients ask what they should be doing financially before the year ends ahead of the tax season. Others are asking what are some healthy money habits to adopt as a New Year’s Resolution in 2020.

Many are already familiar with adding the maximum amount to various accounts before year-end—whether it’s 401Ks, 529 Plans, or IRAs—but they don’t think to include charitable giving as part of a healthy financial plan. (If you are unfamiliar with maximizing contribution, read our previous blog post).

Not only does charitable giving most importantly help those in need, but also it could reduce your tax liability. Below are a few ways giving to charity may also save you money!

Get a Tax Deduction

If you itemize your taxes each year, a charitable donation continues to be a tax deduction even under the newest tax reform, the Tax Cuts and Jobs Act (TCJA) of 2017. In fact, the new tax law suspended the limit on total itemized deductions. This means that you can get full credit for your charitable donation!

Furthermore, the TCJA increased the limit on cash charitable contributions. Previously, you could deduct cash contributions up to 50% of your adjusted gross income (AGI). Now, that number has increased to 60% of your AGI.  This is definitely something to consider during your next round of tax preparation!

Required Minimum Distributions

If you are 70 ½ years old or more, you’re aware that the IRS requires you to take a Required Minimum Distribution (RMD) out of your traditional retirement accounts, such as a 401K or IRA. When you take your RMD, you pay taxes on that withdrawal.

Some people use their RMD to live on in retirement—which that is what it’s there for, of course. However, some people find that they do not need the RMD to cover their expenses in retirement but yet are still forced to take the distribution. Note: if you don’t take the required minimum distribution, you’re subject to a 50% penalty and taxes!

If you find yourself in this situation—or if you’re just charitably inclined—you can transfer up to $100,000 per year directly to a qualified charity without paying taxes on your RMD. Even if you’re required to take less than $100K of an RMD, you’re still able to transfer the full $100,000 that year, if you’d like.

This money does count as your required minimum distribution but does not count towards your adjusted gross income (AGI). So, it doesn’t increase your reported income. Again, a great way to save money on taxes.

Another benefit of this type of charitable giving: Medicare premiums. If you’re on Medicare your AGI is particularly important, since it can affect Medicare premiums.

If you have a year where your AGI increases significantly—due to an RMD or other form of reportable income—your Medicare premium may increase.

So, by lowering your AGI by donating your RMD to a qualified charity, you also will stabilize—or even lower—your Medicare premium that year.

Save on Capital Gains: Think Beyond a Cash Donation

Did you know that you could gift securities—such as mutual funds, stocks, bonds—real estate, and other types of investments?

By gifting investments, you can save money on capital gains tax. When you have a long-term investment holding (1+ years) and sell it at a gain, you owe a capital gains tax. Typically, this rate (0%-20%) is lower than your ordinary income tax, but is a tax, nonetheless.

If you gift an investment directly to a charity, however, the capital gains tax is eliminated!

As many investors are rebalancing their portfolios at year-end, this is a great time to consider donating some of your investments to a qualified charity to minimize capital gains taxation.

Donor Advised Funds

If you are planning to give a donation to charity this year, consider a donor-advised fund. A donor-advised fund is a charitable giving vehicle.

You open the DAF, fund it with either cash or securities, and allow the account to grow tax-free. You are typically able to take the full tax-deduction of the donation in the year you fund the DAF. Often this amount is greater than if you make smaller donations year-to-year.

You then can gift from the DAF to your favorite IRS-qualified charities each year. You can even set up the donor-advised fund with your financial advisor so that they have discretion over the account. This way the money is also monitored and managed.

This is a wonderful way to leave a family legacy, as you can name your fund in their name, for example, the “Johndrow Family Fund.” You can even get your children involved by helping determine what charities the family is donating to each year. What a great way to teach your children the gift of giving, especially during the holiday season!

Offsetting Costs: Converting a Traditional IRA to a Roth IRA

One final way a charitable donation can lower your tax bill: by making a donation to charity, it may offset the taxes of converting a traditional IRA to a ROTH IRA.

A key benefit of a ROTH conversion is to lower your tax bill in the future. Perhaps all of your savings are in a traditional IRA. This means that you’ll be required to take money as a required minimum distribution once your turn 70 ½ years old. An RMD will be considered taxable income and will be counted towards your adjusted gross income (AGI) for the year. As already discussed in this blog, not only do we have to pay taxes on our AGI, but it also may affect Medicare premiums in retirement.

Therefore, clients often convert part of their traditional IRAs into ROTH IRAs in order to pay taxes today, but then allow the ROTH IRA to grow tax-free. ROTH IRAs don’t have required minimum distributions (RMDs) and money used from a ROTH is not counted towards your adjusted gross income (AGI).

A tricky element of a ROTH conversion, however, is that you do owe taxes at the time of the transition. This is where charitable donations can again save you some tax dollars. For this strategy to work, typically someone needs to make a greater charitable gift than typical and would need non-retirement assets to pay for the cost of the conversion. Therefore, it’s very important to contact your financial advisor and tax professional to execute this strategy correctly.

Conclusion

Clearly giving to those in need makes us feel good regardless. But if we are able to donate to charity and also save ourselves some money, we see this as a win-win! Consider charitable giving this season and happy holidays from all of us at Johndrow Wealth Management.

Written by Magdalena Johndrow

Maggie is a Partner and Financial Advisor at Johndrow Wealth Management. She attended Providence College and the London School of Economics prior to beginning her career on Wall Street at Barclays and JP Morgan. She has taken her experience with high net-worth clients and used it to empower families and small businesses.