Americans are known as some of the most charitable people in the world. When natural disasters occur, we donate to relief efforts. We often support causes that friends and family members hold near and dear. At Planning with Purpose, with our passion for education and being self-supporting, we often ask clients to support Mom’s House.
There has also been a trend in high-net-worth individuals to not simply leave a legacy to their children. The concern for them often is that their children need to find their purpose in life and need to work towards their financial independence. Many of these individuals are choosing to leave part, most, or all of their inheritance to one or more charities.
We see many individuals without a spouse or children who struggle with what they want to do with funds they will not need at the time of their death. If you are one of those individuals, do you have an attachment to a charity? Do you desire to help animals, help children, help with medical research for a particular disease, support a spiritual organization, or honor the college you attended? Leaving your funds to these organizations at your death means you have the funds available while you are alive and also know you are helping if there is anything left that you do not need.
Maybe you want to support a charity, but you are not sure if you can without running out of money later in life.
Do you have IRA or employer retirement plans? One possibility is to name one or more charities as a beneficiary. Consider the example of having $100,000 in your IRA account today. If you need the money over your lifetime, great, it is available for you to use it. If you designate 10%, 15%, or even 100% of it to go to your favorite charity, you will be providing a donation to that charity. If the account is worth $20,000 at your death, you have provided a $3,000 donation to your charity if you designated 15% to go to a charity.
If you are splitting multiple types of accounts between family members, friends, and charities, optimizing who gets which funds can minimize the taxes being paid on your inheritance.
What if you have $250,000 when you die between a Traditional IRA account, and a taxable brokerage account containing individual stocks and mutual funds you own? If your heir receives the full value of the IRA, they need to pay taxes on it. Giving that 15% from the IRA to charity means no tax consequences for your heir or for the organization that receives that portion. Meanwhile, your spouse and/or children get the amount in the brokerage account. Currently, they would get a stepped-up basis at death, meaning that the tax would be minimal if the investments were immediately sold.
If, however, your IRA account is a Roth IRA by leaving 100% of the IRA to your heirs, you are providing tax-free income. That account can continue to grow tax-free until distributions are made out of the account. Currently, your beneficiaries would have ten or more years for those distributions to occur. Giving the amount that you want to the charity out of the individual stocks or mutual funds allows the charity to receive them with no tax consequences if they cash in the investments.
Naming a charity as a beneficiary can be done in IRA accounts or employer plans like a 401(k), 403(b), 457, profit sharing, SEP, Simple, or any other employee plans. Since you name beneficiaries on a life insurance policy, the death benefit can be paid to a charity. One of the beneficiaries of your trust might be a charity. Depending on the type of trust, you may or may not be able to change the designation later. Putting a transfer on death or payable on death registration on a taxable account can allow you to leave a portion to a charity.
Changing and adjusting a beneficiary is a simple process. Generally, you fill out a form and file it with the financial institution to change either the beneficiary or the percentage. If you put a charitable contribution into your will, it tends to involve a more complicated process to change either the beneficiary or the amount. It could also have unintended effects since you are not sure of the value of your estate until your death occurs. Depending on the value of your estate at death, it is possible that your estate would go to the charity, leaving no legacy to your children or other family members as intended.
What if you want to make charitable contributions that allow you to get that tax deduction now? With the current higher standard deductions, many find themselves no longer able to itemize and unable to take a current tax deduction.
The solution may be a donor-advised fund. With this particular type of investment account, you make a lump-sum contribution to the account. In the year you contribute to the fund, you take the tax deduction for that contribution. You are then able to disburse the funds from this account over several years – you have the control of to whom, when, how often, and for what amount. You do not get a tax deduction when the amount is paid to the charity since you already got the deduction when it went into the donor-advised fund.
For example, say you and your spouse regularly donate $5,000 a year to various charities. With an itemized deduction amount of over $24,000, you normally are now taking the standard deduction and will get no tax deduction.
Rather than writing those checks each year to the various charities, what if you were to put $25,000 into a donor-advised fund this year? For the current year, you can add the $25,000 charitable contribution to your property taxes, income taxes, mortgage interest, and deductions to itemize for this year.
You now have a $25,000 pot of money that you use to make the donations to your charities. You notify the donor-advised fund when you want them to send a check to the charities of your choice. You can make additional contributions if you want, maybe setting yourself up to itemize on your taxes every 3 or 4 years.
When you set up the donor-advised fund, you will designate one or more charities to get whatever balance remains in your account at the time of death. Whatever is put in the donor-advised fund cannot be taken back either during your lifetime or at your death. You must be careful that what you are putting into this account, you know that you will not need it in the future.
We see several financial institutions allowing you to set up donor-advised funds for a minimum of $10,000. If one of your goals is to take the tax deduction, you may need to make a more substantial contribution to achieve that.
There are also charitable annuities that can be set up to allow for that tax deduction. Your beneficiary then receives either a fixed payment or a percentage-based payment for a period of time. The charity then gets whatever remains in the annuity after your death. If this is a concept that interests you, you will need to investigate a charitable remainder annuity trust (CRAT) or a charitable remainder unit trust (CRUT).
We hope that you have continued providing funds to a charity because you want to support that cause even if you lost the tax deduction. By strategically planning your charitable donations and not being saddled with taxes, would that allow you to give more? It may mean giving more at your death because you no longer have the concern about running out of money, to minimize estate taxes, or to reduce the taxes that your heirs need to pay. It may mean making one donation that is then paid out to charities over the years. There are a lot of options depending on your goals and desires.
