Marie-Claire Hart is a Sophisticated Planning Strategies Attorney at Northwestern Mutual.
You’ve worked hard to build your wealth. Now you’re ready to share it with causes that are important to you.
In a 2021 Northwestern Mutual/Forbes survey, 59 percent of high-net-worth Americans (and 91 percent of high-net-worth Millennials) say that charitable giving is an important component of their overall financial plan. What’s more, respondents indicated that personal conviction, a desire to give back and personal connection were among their most important reasons for giving.
So, whether you give for one of these reasons or something else, it’s smart to make sure you’re taking advantage of available tax benefits. By leveraging an intentionally designed tax strategy that supports your financial and charitable giving plans, you can do more than just reduce your tax liability. You can maximize the impact of your gifts, ultimately putting more dollars to work for the causes important to you.
Here, we’ll walk you through eight key tax strategies that may have a place in your charitable giving plan.
8 Tax Strategies for Charitable Giving
1. Highly appreciated securities
If you own stock or other securities like mutual funds that have appreciated significantly since you purchased them, you might be sitting on a tax-efficient charitable giving tool. Instead of first liquidating the investment, paying tax on your gains, donating the proceeds and taking the charitable deduction on the value of the proceeds, you can donate your securities in-kind to the charity. By making the donation in-kind, you’ll avoid the capital gains tax and be able to write-off the fair market value of the stock on the day you donated it. This both translates into more dollars for your charity of choice and may result in a larger charitable tax deduction, making your gift especially tax efficient.
2. Excess RMDs from your IRA
Do you take required minimum distributions (RMDs) from your IRA? If you do, and you are in a position where your RMDs are beyond what you need to live a comfortable lifestyle, it could be an opportunity for tax-advantaged giving. Excess RMDs increase your taxable income but can instead be donated to charity through what’s called a qualified charitable distribution (QCD). QCDs are made directly from your IRA to your named charity, instead of being distributed to you via an RMD. By donating those excess dollars to charity, you can use a QCD to support causes you care about while reducing your taxable income. It is worth noting, however, that the current annual cap on QCDs is $100,000, so talk with your financial advisor and tax professional to ensure proper execution.
3. Donating your IRA at death
While QCDs are great for lifetime giving, you can also designate a charity as a full or partial beneficiary of your IRA. While most taxable assets like stocks or mutual funds in a brokerage account get a step up in basis at death, enabling your heirs to sell them and owe less tax, IRAs usually must be liquidated in five to 10 years, and those distributions are subject to your beneficiaries’ personal income tax rate. Unfortunately, that means if you leave your IRA to your children, they must pay taxes on the full value of the account as it is liquidated. If a charity is your beneficiary instead, due to its tax-exempt status, no taxes will be owed on the withdrawals and your taxable estate and potential federal estate taxes may be reduced(only taxable estates exceeding $12.06 million in 2022 are subject to federal estate taxes).
Maximize the Impact of your Charitable Gifts
4. Donor-advised funds
Donor-advised funds are essentially charitable investment accounts for the purpose of distributing donations in your or your family’s name to various charities over time. Donor-advised funds enable you to take a charitable tax deduction when you need it and allow you to distribute your charitable donations when you are ready. You can choose to contribute a large donation to your fund in a single year to maximize tax deductions in a year with unusually high liquidity or income. You can also choose to make ongoing contributions to your donor-advised fund as part of regular charitable giving. Money can be invested over time in the account, and the fund can make donations to charities at your request over the course of many years.
5. Private foundations
Private foundations are often created for the same reason as donor-advised funds (more control over your charitable tax deduction and when you distribute dollars to charity), but they are more complicated and expensive to administer. Generally, private foundations are best suited for families looking to make an initial donation of at least $250,000 with a continued time and financial commitment.
6. Split interest charitable giving
Split interest charitable giving allows you to make charitable gifts while also retaining certain benefits of the assets for yourself or your beneficiaries. Split interest charitable giving instruments can include Charitable Remainder Trusts (CRTs), Charitable Lead Trusts (CLTs), Charitable Gift Annuities (CGAs) and Charitable Lead Annuity Trusts (CLATs).
In the case of a CRT, when you transfer your assets into the trust, you keep an income stream from the trust for a set term. When the term of the trust ends, any remaining assets are donated to the charity beneficiary. By creating and funding the trust during your lifetime, you may be able to receive a current charitable deduction on your income tax for the current value of the remainder.
A CLT functions similarly to a CRT but in reverse. When transferring your assets into a CLT, the charity is the one that receives the income stream for a specific term. When the term of the trust ends, remaining assets transfer to you or your beneficiaries, not the charity. Depending on your specific situation, transferring assets into the CLT can create a current charitable income tax deduction.
A CGA allows you to provide a gift to charity in exchange for a lifetime annuity and may create a current charitable income tax deduction for the value of your gift less the present value of the annuity payments.
Lastly, a CLAT is a trust that creates an annual annuity stream to a charity for a specific amount of time. As the donor, you receive tax deductions for a charitable donation while keeping the remainder of the assets for yourself or your beneficiaries.
Split interest charitable giving vehicles are sophisticated, so it’s important to work closely with your financial advisor, tax professional and attorney on implementation of these tools.
As a result of the expanded standard deduction through the Tax Cuts and Jobs Act, even some wealthy individuals and families may find their tax situation benefits from bunching. Whether you are writing checks directly to charities or giving via donor-advised funds or a private foundation, it may be advantageous to make multiple years’ worth of charitable donations in a single tax year. This can increase your itemized deduction above the standard deduction for the tax year, potentially helping reduce your taxable income.
8. Life insurance
Your permanent life insurance policy (like whole life, universal life or variable universal life) can be a great tool for making a large donation to charity. There are two primary ways to use life insurance for a charitable contribution.
During your life, you can leverage your insurance policy for charitable purposes by donating the policy to charity. In this case, the charity becomes both the owner and beneficiary of the policy. Donating a life insurance policy can qualify as a current income tax charitable deduction. The charity could choose to keep the policy in force, potentially having to continue premium payments, with the option to access any available cash value, or wait to collect the death benefit in the future. Many donors choose to help the charity keep the policy inforce by making ongoing tax-deductible donations to the charity to fund the premium. Alternatively, the charity could surrender the policy and take the cash value right away without being subject to any income tax on the surrender.
Another way to leverage your permanent life insurance policy is to make a charity the sole or even a partial beneficiary. While you won’t receive a tax write-off during your lifetime (your estate will receive a charitable deduction instead), this approach enables you to support the causes you care about while reducing your taxable estate and maintaining flexibility. During your life, you’ll continue to have access to the living benefits of your policy like access to the cash value and the ability to change the beneficiary later, if needed.
Your Advisory Team Can Help Maximize the Impact of Your Charitable Giving
While these are some of the most common tax strategies to maximize the impact of your charitable gifts, it’s important to collaborate closely with your financial advisor, tax professional and attorney. Together, your advisory team can help ensure you are leveraging tools that make sense in the context of your personal financial and charitable giving plans.
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company (NM) and its subsidiaries, Northwestern Mutual Investment Services, LLC (NMIS) (Investment Brokerage Services), a registered investment adviser, broker-dealer, and member of FINRA and SIPC, and Northwestern Mutual Wealth Management Company® (NMWMC) (Investment Advisory Services), a federal savings bank. NM and its subsidiaries are in Milwaukee, WI. Not all Northwestern Mutual representatives are advisors. Only those representatives with “Advisor” in their title or who otherwise disclose their status as an advisor of Northwestern Mutual Wealth Management Company (NMWMC) are credentialed as NMWMC representatives to provide advisory services.
This publication is not intended as legal or tax advice. Northwestern Mutual and its Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor. Tax and other planning developments after the original date of publication may affect these discussions.
I'm an attorney in Sophisticated Planning Strategies. I consult with financial advisors on issues related to financial planning, insurance, planning for business owners, trusts and estates, retirement planning, charitable giving, and tax planning.
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