People who are in the financial independence stage of their financial lives — able to cover their expenses without income from a job — have some charitable options available in addition to those open to people in the accumulation stages of their financial lives.
Many people in financial independence are fully or partially retired and no longer have a mortgage. Writing a check to a nonprofit may not produce a tax deduction if there aren’t enough deductions that add up to more than the standard deduction on a tax return. But there are still ways to support charitable causes and get some tax breaks in the process.
If you have an IRA, once you reach age 70½, each year you can do one or more qualified charitable distributions (QCD). This is a withdrawal from an IRA paid directly to a charity. If done properly, QCDs are not taxable like other withdrawals. There are several requirements to have these distributions be tax free. The distribution must be made payable directly to the charity, not to you. The charity must be a 501©3. QCDs are limited to $100,000 per year. If you’re over 70½, you’re taking money from your IRAs to meet your regular expenses, and those expenses include donations to charities, QCDs are more tax efficient than taking money from your IRAs and then writing checks to charities.
A donor advised fund (DAF) is a tax-efficient way to make charitable donations. If you have investments with embedded capital gains held outside of retirement accounts, you can donate some of those securities to a DAF, avoiding the capital gain from selling. You are eligible for the tax deduction in the year that you transfer the securities into the DAF, then you can choose which charities receive the funds at a later date. As an example, let’s say you are a single taxpayer and generally donate $7,000 a year to various charities each year. Those donations, along with your state income taxes and real estate taxes aren’t enough to itemize. You can transfer $14,000 in securities to a DAF this year. If you own a home, your real estate taxes, as well as your state income taxes, can also go toward increasing your itemized deductions. Then you can have the DAF pay the $7,000 to your charities this year. Next year, you can take the standard deduction, but still have $7,000 go to your favorite charities. Even if you already itemize, you can explore increasing your deductions and avoiding capital gains through this strategy. Moving money into a DAF is irrevocable, so don’t transfer so much that you’ll run out of money during your lifetime.
You can only deduct 50% of your adjusted gross income in cash donations per year and 30% of noncash donations. But amounts in excess of the annual limit can be used in future years up to five years. Securities donated to a DAF qualify for the 50% deduction limit.
Linda Leitz is a certified financial planner. She can be reached at linda@peaceofmindfin.com.
