Tax-efficient charitable donations before your retirement

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You have had a successful career and are almost ready to retire. While you’re still in your best earning years, is there a tax-efficient way to give back? During this time, when you are in a high tax bracket, charitable giving can both benefit others and help you prepare for retirement. With a little planning, everyone benefits from your generosity.

Tax cost considerations

With tax-deductible charitable donations, the higher your tax bracket, the lower the actual net cost to you of making the donation. As a simple example, if Jane is in the 37% tax bracket and Jim is in the 0% bracket, a charitable donation of $ 100,000 has a net cost to Joan of $ 67,000 ( because she can deduct the donation), while John’s cost is $ 100,000.

The tax utility of a charitable contribution becomes even more effective when one takes into account both long-term capital gains and ordinary income. Imagine, for example, that Jane is preparing to retire and wants to sell an investment property, but she wants to benefit her local university as part of her planned giving. It is in the upper ordinary tax bracket of 37% and pays the highest capital gains rate of 20%. Is there a way for her to use her high tax bracket to limit the actual cost of a gift to her alma mater? One possibility is to make a partial sale / donation of the property to the university.

Joan sells the school an investment property with a fair market value of $ 100,000 and a tax base of $ 30,000 for $ 60,000. She pays capital gains on the sale portion ($ 60,000) and receives a tax deduction for the donation portion ($ 40,000). Joan effectively receives $ 66,400 – the sale price of $ 60,000 plus the net tax benefit of $ 6,400 (her tax deduction less capital gains on the sale).

Compare this result with selling the property to an arm’s length buyer for its fair market value of $ 100,000. After 20% of capital gains, she would pocket $ 86,000. So, in essence, it costs Joan $ 19,600, the difference between an ordinary sale and the partial sale / partial donation to the university, to make this charitable donation. The university obtains an asset of $ 100,000 for $ 60,000 while costing Joan less than a third of that amount ($ 19,600) to complete the transaction. It is Joan’s tax bracket that determines the low cost of this transaction.

By comparison, if Joan had retired and was in a zero percent capital gains bracket with a regular ten percent tax bracket, her cost for this transaction would be much higher. While she could sell the property to a regular buyer for $ 100,000 after tax, the donation / sale transaction with the university would only earn her $ 64,000 ($ 60,000 for the sale plus her tax deduction of ten percent). Her cost, then, to make this charitable donation as a low-tax retiree is $ 36,000, while her cost as an executive about to retire is only $ 19,600. . As the planning saying goes, “Give while it’s good to give. ”

Retirement income considerations

Another adage goes: “to do well while doing good”. This is exactly what charitable giving can do: benefit a generous person while also generating reliable retirement income. Many planned giving strategies involve donating property to charities in exchange for lifetime income. It can be as simple as making a charitable annuity. Suppose in the example above that Jane wants to donate her $ 100,000 property to her university, but wants to supplement her retirement income. The American Council on Gift Annuities suggests that at age 65, Joan should receive a 4.2% payout rate. By donating the $ 100,000 investment property, she will receive an annual payment until her death of $ 4,200 ($ 100,000 x 4.2%). In addition, even if it also benefits from a partial tax deduction for this donation, the part of the capital gain that is attributable to the tax-deductible part is not taxed. It works just like an outright contribution of valued property to a charity. If she doesn’t need the money immediately, she could make the contribution now, while in a high tax bracket, and ask the charity to start the payments years later. (eg, at age 75). This will provide a higher lifetime income, helping to reduce the risk of “longevity tail” of living too long.

Charitable Annuity is a mini version of more sophisticated income-generating charitable giving strategies such as Charitable Residual Trusts (CRTs). The tax benefits are similar: lifetime retirement income for the donor, an initial ordinary income tax deduction for residual interest in the charity, and avoidance of capital gains tax. With CRTs, the gift can be a fixed lifetime annuity payment (CRAT) or income based on a percentage of the fair market value of the trust assets (CRUT).

These types of transactions are most valuable when the future retiree is still in a high tax bracket. First, as demonstrated above, the after-tax cost of a charitable donation is lower the higher your tax bracket. Second, keep in mind that charitable donations only positively affect taxes when viewed as itemized deductions. While a taxpayer who uses the standard deduction may benefit from the positive feelings associated with charitable giving, it does not benefit from a tax standpoint. From a practical standpoint, a high-income pre-retiree is more likely to detail deductions than a low-income retiree. As a result, smart tax planning requires that you take the deduction when your taxes are high, and then when you subsequently start receiving income from the charity, any tax on those payments will be taxed in your income bracket. lower retiree tax. And one final benefit: there are limits on the amount of charitable deductions that can be deducted from your adjusted gross income. Before you retire, you will have more income against which the deduction will be deducted and you will be less likely to reach the deduction limit.

Estate planning considerations

With the prospect of inheritance and gift taxes soon affecting more Americans, these transfer taxes should be factored into the future retiree’s charitable giving plan. All the assets you don’t need in retirement can be great candidates for charitable giving, and they can potentially avoid gift and estate taxes. Rather than letting the assets remain in taxable wealth, take advantage of the income tax deduction now and remove the asset from potential taxation. Examples include the donation of illiquid and illiquid business interests, hard-to-value assets, and other investments that earn little income. A qualified appraisal is usually required to justify the fair market value of these assets, so it’s important to start the process early, while you are still in a high income tax bracket.

Another consideration in estate planning is that before you retire, it would be advisable for your retirement advisor to speak with your estate planner. Take the example of life insurance. Suppose in the example above that Jane has a life insurance policy of $ 1 million on her life with a current value of $ 50,000. She isn’t sure whether she needs the police in retirement and wonders if she should just give the police over to her university. On the one hand, the police donation would currently provide a useful tax deduction while she is still in a high tax bracket, and this relieves her of making future premium payments. However, while the top income tax bracket is 37%, the estate tax rate is 40%. One planning consideration is to keep the policy. Joan could, for now, make the university the beneficiary of the policy and have the option of replacing the beneficiary if his needs change during retirement. With this approach, when Joan dies, the university receives a charitable donation of $ 1 million and her estate will deduct the entire $ 1 million from her adjusted gross estate. From a legacy and recognition perspective, it may be more appealing to Joan. Instead of “buying a brick” for the university’s new gymnasium, with her million dollar donation, she donates the whole gymnasium!

Maintain flexibility

The life insurance example above highlights the importance of maintaining flexibility. For many people preparing for retirement, there are competing interests in their time. While the tax benefits of giving pre-retirement charitable donations are compelling, as a pre-retiree, you may not yet be sure who you want to benefit from it. A useful charitable planning strategy for this situation is Donor Advised Funds (DAF). With a DAF, you can make a tax-deductible donation while still in a high tax bracket, but wait until later to decide which charities should benefit. So, for example, Joan could donate the $ 100,000 investment property to a CFO of a community foundation before retiring, taking the deduction when it is most valuable. Once she is retired and has some free time, she can then decide which charities she wants the funds to be directed to. An added benefit of this approach is that if, in retirement, she wishes to add to her DAF account, then she can “pool” her contribution to maximize the tax benefit of each donation. One year, she makes a large donation and deducts the donation by detailing; the following year, she does not donate and simply takes the standard deduction. And yet, throughout the process, she can maintain a continuous flow of charitable giving to deserving organizations.

You will have a lot of decisions to make before you retire. If you are concerned about taxes and want to donate effectively to charity, there are tax strategies that, if well planned with retirement, can generate benefits for all involved – both you. as a taxpayer and the charities you want to benefit from.


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