Maximizing Charitable Donations and RMD Options for High Earners and Those Nearing Retirement

Charitable giving is a powerful tool for individuals seeking to leave a lasting legacy, support causes that align with their values, and, in some cases, reduce their tax liabilities. For high earners and those nearing retirement, the interplay between charitable donations and Required Minimum Distributions (RMDs) can offer significant tax advantages. As you approach the age where you must start withdrawing funds from your retirement accounts, it’s essential to consider how strategic charitable contributions can help you manage these distributions efficiently.

In this article, we’ll explore various charitable giving strategies and how they interact with RMDs, offering potential tax-saving opportunities for high earners and retirees.

Understanding Required Minimum Distributions (RMDs)

RMDs are the minimum amounts that the IRS requires retirees to withdraw annually from their tax-deferred retirement accounts, such as Traditional IRAs, 401(k)s, and 403(b)s, starting at age 73 (or age 72 for individuals who reached this age before 2023). These withdrawals are considered taxable income, which can push retirees into higher tax brackets and potentially increase taxes on Social Security benefits and Medicare premiums.

For high earners, managing RMDs effectively is crucial to avoid hefty tax bills. This is where charitable donations can be an excellent tool—not only for philanthropy but also for reducing taxable income.

Charitable Giving and RMDs: The Basics

When it comes to charitable donations, many people are aware of simple cash contributions. However, high earners and retirees have access to a broader array of strategies that can both maximize their charitable impact and minimize taxes. The key is finding the right combination of charitable giving strategies and RMD management to optimize tax benefits.

Let’s dive into some of the most effective options available to high earners and those nearing retirement.

1. Qualified Charitable Distributions (QCDs)

One of the most tax-efficient strategies for individuals over the age of 70½ is making a Qualified Charitable Distribution (QCD). A QCD allows retirees to donate up to $100,000 per year directly from their IRA to a qualified charity without including the distribution in their taxable income. This means the amount donated counts toward your RMD for the year but is excluded from your Adjusted Gross Income (AGI), potentially lowering your overall tax burden.

For high earners, QCDs offer several key benefits:

• Lower taxable income: By reducing your AGI, you can also reduce the tax impact on other sources of income, such as Social Security benefits and Medicare premiums.
• Avoid RMD-related taxes: Instead of taking the RMD and paying taxes on the full amount, you can use a QCD to meet your RMD requirements while supporting a charity and avoiding taxes altogether on the distribution.
• Generosity with a tax advantage: You can support causes that matter to you while optimizing your tax situation.

It’s important to note that QCDs can only be made from IRA accounts and are not allowed from 401(k)s or other employer-sponsored retirement plans unless the funds are rolled over into an IRA.

2. Donor-Advised Funds (DAFs)

For those who may not be ready to make a significant charitable donation all at once but want to take advantage of tax benefits in a high-income year, a Donor-Advised Fund (DAF) is a great option. A DAF allows you to make a charitable contribution, receive an immediate tax deduction, and then distribute the funds to charities over time.

For high earners nearing retirement, contributing to a DAF can be especially advantageous:

• Bunching deductions: In years when your income is high or you need to offset a large tax bill, contributing several years’ worth of charitable donations to a DAF allows you to bunch deductions into one year. This can push you over the standard deduction threshold, enabling you to itemize deductions and reduce your taxable income.
• Control over donations: While you receive the tax deduction upfront, you can take your time deciding which charities to support and when to make the donations.
• Avoid capital gains taxes: If you donate appreciated assets (such as stocks) to a DAF, you can deduct the full market value of the donation and avoid paying capital gains tax on the appreciation.

3. Charitable Remainder Trusts (CRTs)

A Charitable Remainder Trust (CRT) is a more complex, yet highly effective, charitable giving vehicle for high earners and retirees. With a CRT, you can donate assets into a trust that pays you (or your designated beneficiaries) an income stream for life or a specified number of years. At the end of the trust’s term, the remaining assets go to a charity of your choice.

Benefits of a CRT for high earners and those nearing retirement include:

• Income stream: You receive income from the trust, which can help supplement retirement income.
• Tax deduction: You get an immediate charitable deduction for the present value of the remainder that will go to the charity.
• Capital gains tax avoidance: If you contribute appreciated assets (such as real estate or stocks) to the trust, you avoid paying capital gains taxes on the sale of those assets.
• Estate tax reduction: Assets transferred to a CRT are removed from your taxable estate, reducing the estate tax liability for your heirs.

4. Combining Charitable Donations with Roth Conversions

A Roth IRA conversion can be a valuable strategy for high earners nearing retirement, as it allows you to convert pre-tax retirement funds into a Roth IRA, where future withdrawals will be tax-free. However, the downside is that Roth conversions are taxable in the year they occur, potentially pushing you into a higher tax bracket.

Here’s where charitable donations come in: by combining charitable contributions (such as donating to a DAF or using a QCD) with a Roth conversion, you can offset some of the tax liability from the conversion. For example, you could make a large donation to a DAF, take the immediate tax deduction, and use it to reduce the tax impact of the Roth conversion.

This strategy is particularly effective for high earners or those with large pre-tax retirement balances who want to manage their future tax exposure.

5. Stock Donations: Leveraging Appreciated Assets

Donating highly appreciated stock directly to a charity is another effective way for high earners and retirees to reduce their tax liability. By donating stock, rather than selling it, you can avoid capital gains taxes on the appreciation while still receiving a tax deduction for the full fair market value of the stock.

For those nearing retirement, this strategy can be used to:

• Rebalance your portfolio: Donating appreciated stock allows you to reduce your exposure to highly appreciated positions in your portfolio without triggering capital gains taxes.
• Support causes while maximizing tax benefits: This approach offers a double tax advantage—no capital gains taxes and a charitable deduction.

Which Strategy is Right for You?

The best charitable giving strategy for you depends on your unique financial situation, retirement goals, and philanthropic desires. Here are some key considerations to guide your decision-making process:

• Do you need to reduce your taxable income this year? If so, consider a QCD or contributing to a DAF to offset your income with a charitable deduction.
• Do you have highly appreciated assets? Donating appreciated stock to a charity or DAF can help you avoid capital gains taxes and reduce your portfolio’s risk.
• Are you looking to create an income stream in retirement? A CRT could provide both tax benefits and an additional income source.
• Are you planning a Roth conversion? Pairing a charitable donation with your conversion could help minimize the tax impact.

The Bottom Line

For high earners and those nearing retirement, charitable giving isn’t just a way to support meaningful causes—it’s also an opportunity to optimize your tax strategy. Whether you choose to make a QCD, contribute to a DAF, donate appreciated stock, or establish a CRT, each strategy offers distinct tax advantages that can complement your overall retirement plan.

To ensure you’re making the most of your charitable donations and RMD options, it’s important to work closely with a financial adviser or tax professional. They can help you navigate the complexities of the tax code and design a strategy that meets your financial and philanthropic goals.

If you have any questions or would like assistance in developing a charitable giving strategy, please don’t hesitate to reach out to our office. We’re here to help you make informed decisions that benefit both you and the causes you care about.

 

Sources:

• https://keitercpa.com/blog/2021-tax-planning-using-charitable-contributions/

• https://www.fidelitycharitable.org/guidance/philanthropy/what-is-a-donor-advised-fund.html

• https://www.aefonline.org/blog/roth-ira-tax-free-conversions-through-donor-advised-fund#:~:text=A%20client%20can%20establish%20a,resulting%20from%20the%20Roth%20conversion.

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