The majority of people who participate in some level of charitable giving in retirement aren't getting a tax deduction for any of it. While external reasons should drive charitable giving, you should absolutely look to maximize the tax effectiveness of any giving you're already doing.
In this episode, James covers how to optimize your tax benefits, detailing donor-advised funds, an often-overlooked tool for maximizing your tax benefits.
Learn about when to write off cash contributions, gift appreciated securities, and how your mortgage can play a role in the deductibility of your giving.
What should you do differently with your tax strategy when making charitable donations?
When does a donor-advised fund make sense for you?
4:02 Why it matters
6:15 Donor advised fund
11:03 Important information
14:16 When does it make sense?
17:43 When does it not make sense?
Create Your Custom Strategy ⬇️
The majority of people I meet with who do some level of charitable giving in retirement aren't actually getting into tax deduction for any of it, and while charitable giving should be driven by reasons I have nothing to do with taxes, you should absolutely look to maximize the tax effectiveness of any giving you're already doing. A donor-advised fund is an excellent way to do this, and in today's podcast, I'll show you how. This is another episode of Ready for Retirement. I'm your host, james Kanol, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. So just a bit of background before we go into today's episode, because prior to 2018, I would say, this strategy was not used a whole lot, and maybe I shouldn't say it wasn't used a lot, but it wasn't used to the extent that it now makes sense to use it today. Well, what happened in 2018? New tax law went into effect and one of the changes with new tax law is a standard deduction went up pretty dramatically. So, if you go back to 2018, the standard deduction for a married couple was $13,000. For 2023, that standard deduction is $27,700, or, if you're both 65 or older, $30,700. So, for the sake of this podcast, I'm going to use that $30,700 number as an example. If you're single, you can simply cut that in half. The standard deduction just doubles based upon your married status or your tax filing status. But what does that mean? What does the standard deduction even mean? Well, the IRS says you can deduct things on your tax return Things like mortgage interest, things like charitable giving, things like state and local taxes up to a cap. So when you go to file your tax return, you add all of these things up. Now, this isn't a comprehensive list when I talk about mortgage interest, charitable giving and state and local taxes, but they're the three most common deductions. So when you go to file your tax return or your CPA goes to file your tax return, if you add all those things up and it's greater than $30,700, then you can use that number for your deductions and that's called an itemized deduction. Itemized meaning you list out here's how much I had a mortgage interest. Here's how much I had in state and local taxes. Here's how much I had in charitable giving. But if it's less than $30,700, again, I'm using the number for 2023, people who are 65 years old and older if it's less than $30,700. When you add up all these items, then the IRS says you can just use something called the standard deduction, which is $30,700. Now this is nice because let's say you only have $20,000 of deductions. Well, you still get to write off $30,700 on your tax return, even if you only have $5,000 or even $0 in deductions. When you add up state taxes, charitable giving, mortgage interest, things like that even hypothetically, if you had $0 of any of those, you could still deduct $30,700 on your tax return. Now, this isn't a tax credit. It doesn't reduce your taxes by $30,700, but reduces your taxable income by that amount. So, for example, if you earned exactly $130,700 and you're married finally and jointly and you're both 65 or older, then you take that standard deduction and you only pay taxes on $100,000. So you earn $130,700, but $30,700 is deducted from your earned income and you're paying taxes on the remaining $100,000. So in 2018, when they raised the standard deduction and when they capped state and local property taxes, what that means is, no matter how much you pay in state taxes, whether it's state income taxes or property taxes you can now only deduct $10,000 per year. When they made those changes, you had 30% of the population prior to 2018 was itemizing our tax return. Now, only about 10% of the population itemizes their giving and the remaining 90% simply uses the standard deduction. So why does this matter? Seems like a good thing. In general, more people are taking advantage of a higher deduction. Well, here's why it matters. If you are giving, so, if you're doing charitable giving, and if your total deductions don't exceed 30,700, you're really not getting to deduct any of your giving at all. Quick disclaimer as I said at the beginning, your giving should have nothing to do with tax deduction. You should give out of the goodness of your heart. You should give because you care about. You shouldn't be doing it for the tax deduction. But also, like I said at the beginning, if you are giving to a charity a qualified charity let's do all that we can to get the tax benefit for that. So let me actually walk you through an example something that's very common in what I see where people are giving and they're giving very generously, but they're actually not getting any tax benefit for doing so. Let's assume that we have a couple and they're both 65 years old and they're giving $15,000 per year to charities. Let's assume that this couple's retired and that before retirement, they paid off their home, so they no longer have any mortgage interest that they can deduct. And let's assume that they pay $20,000 in state taxes between their property taxes and their state income tax, but they can only deduct $10,000 of it. So, again, part of the state and local tax cap is it doesn't matter how much you pay in state and local taxes. The max that you can deduct is $10,000. Let's use an extreme example with this couple. Let's assume that for the next 30 years, they continue to give $15,000 per year, for the rest of their lives, or at least for the next 30 years. Keep in mind and this is why I say this is an extreme example current tax law is set to sunset at the end of 2025. And it could be extended, which means current brackets could stay in place. But if it doesn't, tax law reverts to 2017 levels and at that time, standard deductions were $13,000, which would be adjusted for inflation, so it'd be a bit higher when things revert. But the bottom line is we probably won't have the same exact tax brackets forever. We almost certainly won't. But let's run the analysis as if we did just to illustrate this concept, and then we'll understand the disclaimers and the nuance of all this, of how would changing tax law actually impact some of this? But before we do so, if we just carry on with that analysis, let's understand what would the deduction be for this 65 year old couple. Well, number one is mortgage interest. But, as I mentioned, they don't have a mortgage anymore. They paid off their home, so there's $0 that they get to deduct there. Number two is state and local taxes. They pay $20,000 in state and local taxes, but the cap that they can deduct is limited to $10,000 on their federal tax return. So now we can take $10,000 of that and deduct it. Then, finally, we have their charitable giving, and they're giving a pretty healthy amount. They're giving $15,000 per year away. So what we have now is we have $10,000 in state and local taxes, we have $15,000 in charitable giving. That adds up to $25,000. Well, as I mentioned before, the standard deduction is $30,700, which means they're under the standard deduction, which means when they go to file their taxes, they're not going to itemize, they're just going to take the standard deduction. So, technically, because of that, over those 30 years, even though in this case they would have given $450,000 away to charity, they've deducted none of it because they've simply taken the standard deduction every single year over the course of that time, again assuming in this example the tax law stays as it currently stands. So when I tell clients this, sometimes they're shocked to hear that they're not getting any deduction. Other times they just kind of say, yeah, I guess that's the way it is, but I tell them there's a better way to do it, and that's where the donor advised fund comes into play. Let's say, for this example client that we just talked about, they have their investments and they have traditional IRAs, roth IRAs, and they also have a joint brokerage account. Here's what I propose to them. I'll say let's use something called a donor advised fund. Think of it as a giving fund. Now, with this giving fund, so as donor advised fund, anything you gift to it is an irrevocable gift. So if you give $20,000 to it, you can't take $20,000 back. However, you do control how that gift is invested and you do control how that gift ultimately gets given over the course of time, because when you give money to the fund, you still retain control over the fund, even though it's irrevocable. Let's assume I put $20,000 into my donor advised fund today. I control how that $20,000 is invested and, more importantly, I control the timing of when that $20,000 is actually given. So hypothetically, and maybe not even hypothetically, but in this client situation, what we proposed was we said you're given a very healthy amount of money to charity. What if I'm just going to throw a number out there what if we took $100,000 from your brokerage account which you're planning on using to give to charity over the next number of years? What if we took $100,000, gifted it, not to any one of these individual charities today, but gifted that to your donor advised fund? What that does is you now control still all that $100,000. But the benefit is you get to deduct all of that this year. So if we use the same numbers as before, that's $100,000 now in charitable giving that they could deduct, and the $10,000 and stay in local taxes above and beyond that that they could deduct. So now you have one massive deduction of $110,000 this year that will really drive your tax bill lower. There are rules on how much you can deduct with a charitable gift to a donor advised fund and those rules are different whether you give a cash gift to the donor advised fund versus if you use appreciated securities to give to the donor advised fund, but regardless, there's now a substantial deduction that they can use, and any of that deduction that they can't fully use this year because maybe it exceeds the limits of how much they can deduct, they can carry forward that to future years. Hey everyone, it's me again for the Disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. So, going back to this couple example, I propose to them let's put $100,000 into this donor advised fund. This isn't $100,000 you have to come up with your bank account. Let's just shift some money in your existing portfolio that you were already intending so it's already kind of earmarked to use for gifting. Let's front load your fund today. You get a major tax benefit today and now, going forward, instead of using funds from your brokerage account to gift $15,000 per year, well, let's simply give it from your donor advised fund. With $100,000 in there, that fund might last seven years, eight years or longer, because keep in mind that money is now growing. So if we put $100,000 in, if it's grown by even a few percent each year. That's money that you can now use to gift and none of that growth is taxable to you and it's just more money that you can ultimately give to charities. Here's some important information to know about donor advised funds. Number one any cash contributions that you make to donor advised fund. You can write off up to 60% of your adjusted gross income via a donor advised fund. For example, let's assume your adjusted gross income is $100,000 and let's also assume that you gift $100,000 to a donor advised fund. What you cannot deduct the entirety of that $100,000 gift. The most that you can write off is 60% of your adjusted gross income. So if your adjusted gross income is $100,000, $60,000 is the limit of how much you can write off on your taxes that year, assuming you made that donation via cash. Now, anything that you don't write off this year, you can carry that forward for up to five years. So if you write off $60,000 this year, you could potentially write off up to remaining $40,000 the following year. So that's one thing to keep in mind is there are some limits as to how much you can deduct each year. Now here's a beautiful thing about donor advised funds is you don't have to just gift cash. You could gift appreciated securities. So, in that same example, what if you bought Apple for $1,000 years and years and years ago, and now it's worth $100,000? Well, you could gift Apple stock directly to your donor advised fund. Here's the amazing thing about that is that Apple stock, depending on your tax bracket, might only be worth $75,000 or $80,000 to you if you're in a higher tax bracket, but if you gift the $100,000 worth of Apple stock with $99,000 of unrealized gains, you get the tax deduction of the full $100,000 in. Your donor advised fund gets the full $100,000. So it's an amazing way not just to lump all of your contributions into one year all of your charitable giving, I should say into one year to take advantage of a massive deduction, but it's also a great way to avoid taxes on an appreciated asset. Here's the thing with that, though, is if you're not giving to your donor advised fund with cash, but instead you're giving with appreciated securities and, by the way, securities could be stocks, it could be mutual funds, it could be businesses, it could be real estate. So there's a lot of things that you can actually gift to a fund. 30% of your adjusted gross income is the cap on what you can deduct. So in that same example, let's assume you earn $100,000 per year, you have the Apple stock worth $100,000 but you only paid $1,000 for it. I'm assuming you bought way back when you could only deduct. If you gifted that full $100,000 of Apple stock to donor advised fund, $30,000 on this year's tax return because 30% of your adjusted gross income is the limit. The remaining amounts could carry forward again to future years. But that's something that you need to be mindful of when you're doing your tax planning and your giving planning. So that's a basic overview of how donor-advised funds work and how they can save you a lot of money and taxes simply rearranging the way that you do your current giving. But let's talk about when they do make sense and when they typically don't make sense. Of course, this isn't universal, but this is just broad guidelines. Make sure you're talking with your tax planner and your financial advisor about what makes most sense for you. But when does a donor-advised fund make sense for you? Well, number one if you're doing a fair amount of plan giving to start with, if you're giving a few hundred bucks here and a few hundred bucks there, you're probably not going to do a donor-advised fund A donor-advised fund, you're going to want to do a more significant amount of giving, because you're already planning to do that giving anyways. So if you're planning on giving six grand, eight grand, ten grand per year or more, that could absolutely be a case where setting up a donor-advised fund makes a lot of sense. The second instance is you have no mortgage or a small mortgage. Now, what on earth does a mortgage have to do with your giving? Well, nothing in terms of the actual giving. But it has to do everything when you actually factor in the deductibility of that giving. If you have a large mortgage, or even a medium-sized mortgage, chances are good that you're going to be itemizing your deductions. Let's assume you have a $600,000 mortgage and you are paying $25,000 per year in mortgage interest on that mortgage. Well, that, plus some state and local taxes, that alone probably is already putting you into the zone where you're going to be itemizing your deductions. So any charitable giving you do, above and beyond that, you are taking advantage of that from a tax perspective because you are adding that to the deductions that you're able to take. But if you don't have a mortgage, if you have a very low mortgage, it takes a significant amount of giving to actually get up and over the standard deduction limits. So when I'm reviewing a client's tax return to do some tax plan for them, one of the first things I'm looking at is really, do they have a mortgage and, if so, how much mortgage interest are they paying? Because if they're paying very little mortgage interest and they're doing a pretty significant amount of charitable giving or even a fair amount of charitable giving, that's where a donor revised fund likely makes a lot of sense. Another time where it might make sense is you are in a medium to high tax bracket, even if you're already itemizing your deductions. Let's assume that you're working right now and you have a very high income job. Let's assume you're in the top tax bracket, you're at 37% federally plus whatever your state tax bracket is. But let's also assume you're going to retire next year and when you retire your income is going to drop way down. Well, when your income drops way down, any charitable giving you do in those years it doesn't save you as much in taxes. Because, for example, let's assume that you're in a 10% tax bracket and you give $10,000 to charity and you deduct all of it Again. What it's doing is it's not offsetting your taxes, it's offsetting your taxable income. So if you reduce your taxable income by $10,000 when you're in a 10% tax bracket, it's really only saving you $1,000 in taxes. That's 10% of $10,000. Let's assume you're in your final year of work. Do you want to lump a lot of your giving in that year Not necessarily giving it directly to the charity, but giving it to your donor-advised fund and then in subsequent years using those funds to gift directly to the charity? What that does. Let's assume you're in a high income tax bracket in a high income tax state, say California. Well, if you gift $10,000 extra to donor-advised fund that year, that saves you 50% in taxes between federal and state. So that $10,000 gift saves you $5,000 in taxes. So looking at your tax bracket is another important consideration when determining if this is right for you. So that's when doing a donor-advised fund might make sense. Let's now talk about when it might not make sense. For one there's an option is if all of your money is in a traditional IRA and retirement, it probably doesn't make sense to do a donor advice fund. Why is that? Well, any gifting that you need to do to your donor advice fund has to come out of your IRA. So let's go back to a previous example. We talked about maybe gifting $100,000 to a donor advice fund. Well, if you're taking $100,000 out of your IRA so that you can take $100,000 to gift to your donor advice fund, sure, you're getting a major tax deduction, but you're also creating excess income because you took money out of your IRA. So any benefits of the donor advice fund in that specific example would likely be 100%, and maybe even more than 100%, offset by the liability of pulling funds out of your traditional IRA. Now, quick side note one thing that I like to pair with donor advice fund contributions is a Roth conversion. So I'm not getting into that too much in today's podcast, but there's an excellent strategy where, if you're going to do a donor advice fund that's going to create a major tax deduction, well can we quote unquote manufacture income on the side to use to write off against? In one way that we can manufacture income is via a Roth conversion. So do you do a Roth conversion simultaneously, or at least in the same year that you're implementing this donor advice fund strategy? It creates a bunch of income from the conversion, but then you're able to deduct a bunch of that income because of the gift to the donor advice fund. So that's just a side note there. But in general, going back to the other point of when does it not make sense is if all of your money's in an IRA. The second time it doesn't make sense and this is kind of a tag along there is if you can do qualified charitable distributions instead. So if all of your money's in an IRA but you're saying, geez, I really do a lot of charitable giving, I would love a way to give more tax efficiently. Well, maybe look at qualified charitable distributions instead of a donor advice fund. The qualified charitable distribution says as soon as you turn age 70 and a half, you can take pre-tax funds from your traditional IRA and gift them directly to the charity of your choice. The benefit of that is any money you gift directly to the charity. That's not money you have to withdraw and then pay taxes on. So you can treat your IRA like a giving fund in many ways. You just have to wait until age 70 and a half to make that happen. So if you're that age and if it makes more sense to your plan, a lot of times qualified charitable distributions make more sense than a donor advice fund. In many cases, a combination of donor advised fund giving and qualified charitable distribution giving makes a lot of sense for people who are charitable inclined. The other case where it does not make a lot of sense is if you're not charitable inclined to begin with. So no amount of giving to donor advised fund is going to offset the cost of giving. So if giving isn't a part of what you do, then it becomes a cost. Now, if it's part of what you do, you don't really view it as a cost. You just view it as part of you, part of your generosity, part of what you are doing. But if you're just trying to use a donor advised fund to get more of a tax deduction than it costs you to actually make the gift, that's not going to happen. So don't think of this as like the magical strategy that all of a sudden can make something out of nothing. It's not that it's saying if you're already doing the giving, let's take advantage of that, but it's not going to save you more in taxes than it will cost you in terms of the actual gift. And then the final instance where I would probably not do a donor advised fund, although it could still make sense but maybe not as likely is if you would already itemize your deductions even without charitable giving. If you recall from the beginning, one of the main reasons donor advised funds, in my opinion, have become more and more practical is because fewer and fewer people are actually itemizing their deductions. And if you're not itemizing your deductions, any giving you do is just not necessarily a tax benefit for you. So if you are already itemizing your deductions, then any giving that you do is likely to be deducted on your taxes. Most, if not all, of it is already going to be deducted on your taxes. So if that's the case, less of a need to look at a donor advised fund Now. You could still use it. In that example I mentioned before of maybe you're in your final peak earning years where you're earning a lot of income and you want to take the tax deduction for any giving you do now, as opposed to in future years when you might be in a much lower tax bracket. Still a good case to do donor advised fund there, even if you're already itemizing your deductions. But this is where having a good overall strategy comes into play. This should not be something that you just do because you heard it on this podcast or because you heard someone talk about it. You should really incorporate it into your income plan, your tax plan, your investment plan. How does this best fit in? Because there are a number of variables that you should be looking at any time you decide to do this. So that is a good place, I think, to wrap up for today. A little bit of detail around donor advised funds, how they work, what some of the limits are, why you would choose to incorporate them, and then really some context around when does it make sense to implement a donor advised fund? Do when does it not make sense to implement a donor advised fund? It's not for everybody, but for the people it is, for. This can quite literally save tens of thousands of dollars, if not more, of the course of retirement. And that's before you start pairing donor advised fund strategies with other cool things like Roth conversions or other tax planning factors. So make sure that you talk with your tax planner, make sure you talk with your financial planner before you implement something like this. But when done correctly, it can be quite effective. So that is it for today's episode. If you are enjoying this, I would really appreciate it if you leave a review, if you've got any value or any benefit of any of these episodes, let me know by leaving a review on Apple Podcasts or Spotify helps more people find the show and then also check us out on YouTube YouTube under James Cannell is the channel name and there you'll find this podcast as well as other great information about retirement planning and ultimately, help you to get the most out of life with your money. So leave a review, tell a friend or a coworker or a family member about this podcast. Thank you for listening and I'll see you next time. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom and click start here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.