December 31, 2024
Making the Most of Your Donation: Tax Mitigation, Legacy Planning, and More
December 31, 2024
Donations—whether through direct cash, trusts, or assets—stem from something more than money.
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Merrill Lynch found in its study back in 2022 that almost 7 out of 10 donors cited personal beliefs and values as the reason they gave to a nonprofit.
Yet, money still matters. Because how and when you donate can impact your financial health. A sound strategy for charitable donations can strengthen your overall portfolio while enabling you to create a positive impact.
Before we dive into your options, let’s pick apart a common example—and what can go wrong.
One of the best benefits of donating is getting taxed at a lower income bracket through adjusting your gross income. But it can be easy to overshoot donations and end up increasing your spending. This is exactly what happened in this scenario.
Sarah and Mike are high-net-worth individuals nearing retirement in North Carolina. Together, their adjusted gross income is $380,200, resulting in a 32% tax rate in federal income taxes.
They calculate that charitable donations can lower their adjusted gross income by 19.5%, and if they donate $85,000, they will drop their tax obligation to the lower tax bracket. Their gross income will now show as $363,625, reducing their tax rate from 32% to 24%.
But is that significant savings? At 32%, they would be paying $121,664 in taxes. Under the 24% tax rate, they would pay only $87,270 in taxes. But when you count the $85,000 donation, they paid more than they saved.
This is why charitable giving needs to be planned. To jumpstart the planning process with your tax professional and financial advisor, it helps to know the different types of donations.
There are primary options to make charitable donations that will affect your finances:
Cash is often the fastest and most convenient way to make a gift. But offers the least amount of benefit for high-income donors in terms of growth and estate planning. You can’t give anonymously or leave a successor.
Asset donations work the same way, whether that’s a vehicle, securities, pieces of art, or real estate. These assets must often be converted to cash, either by the donor, a third-party agency, or the charity.
The most popular donation method is the Donor-Advised Fund (DAF). You can gain a comparable tax deduction to cash gifts—with many more benefits. Income tax reductions range from 60% for cash and 30% for appreciated assets within the fund. It’s possible to earn interest in these funds, donate non-cash items, and there is no tax on investment income.
Many investors choose to use DAFs in their legacy planning, as they can choose to leave the fund to a successor. But the various types of charitable trusts can offer similar benefits.
Charitable trusts can be used to donate to nonprofit organizations and foundations. The income tax deduction is less clear and hinges on both the nonprofit and how the trust is designed.
In short, donors can rely on two major trust types:
Both of these options can also use sub-types of these trusts, using either annuities or unitrusts. A unitrust recalculates the gift amount annually based on the asset amount in the trust.
As we can see, there are multiple ways to give. But how can you ensure these donations work for you? Let's look at three more examples.
Raj wants to donate $500,000 of his stocks to a nonprofit local children’s hospital. Rather than cash out his stocks and donate the funds directly, he works with his advisors and the nonprofit to set up a DAF. As a result, he is able to avoid a 20% capital gains tax, or $100,000.
When combined with approximately $85,000 in tax savings based on the appreciation of assets based on a 37% tax rate, the DAF has enabled Raj to make a positive impact without sacrificing financial stability.
Norah, a 73-year-old widow, receives an inheritance of $500,000 upon her partner’s passing. She wants to donate money to charity, but needs to supplement her current portfolio due to rising care costs.
She invests the $500,000 in a charitable remainder annuity. The sum is invested in securities and she will receive a $35,000 payout in the first year. She will receive the same amount every year until her passing. Assuming the returns for the fund is 8%, the fund continues to grow despite the payouts.
When she dies 3 years later, the new trust total of $507,142 is donated to her designated charity.
Stefan wants to leave his wealth to his son, Mark, but also support his favorite animal shelter—a place that not only embodies his values but is the center of fond family memories. He names Mark the successor to a DAF worth $1,000,000, enabling him to avoid a 40% estate tax rate and accrue tax benefits for his heir while designing a family legacy.
Donations can be a key part of your financial strategy, if used wisely. Due to the complexity of the tax code, it is often helpful to work with both a financial advisor and tax professional to optimize your giving.
But it’s only a part of your portfolio.
A sound advisor offers comprehensive advice, and sees your portfolio as more than numbers. Because, at the end of the day, your finances are meant to support you and your values.
If you are looking for a second opinion, you can book a call with us today to discuss your financial and life goals.
You can book a complimentary session
or call me at +1 (828) 884-8840.
