At Merriman we love giving back to our communities, whether that be in charitable donation matching dollars or using our individual allotment of volunteer hours. And in some instances, it also allows a group of us to enjoy a volunteer experience together.
In a recent review meeting, Wealth Advisor Mike Ersser, learned that a client of ours volunteers with the Washington Trail Association (WTA). Discussing their mutual enjoyment of spending time outdoors here in the Pacific Northwest prompted an idea – why don’t I organize a Merriman group to volunteer!
A large part of our team enjoys spending time in our gorgeous parks and trails in the area and what sometimes gets forgotten is the need for trail maintenance and support. So, a workgroup was created, and they hit the trails last week at Sharpe Park in Anacortes, Washington.
They had a fun and active day starting a rock turnpike, performing duff and trail clearing, and making some new friends and memories in their work party.
If you’re interested in getting involved with the Washington Trail Association, more information can be found here.
Whether it’s your time, money or a box of things from your garage – giving feels good. Donating cash or writing a check to your favorite charity is an amazing way to give back. It’s also fairly easy and the most obvious method for charitable donations, but it may not be the best strategy. So, before you reach for your check book, make sure you understand your options.
One of the problems with donating cash at the bank is that for many people, there’s no Federal tax advantage. That’s because the IRS doubled the standard tax deduction in 2018 and limited certain deductions we used to be able to itemize. Depending on how you file and how old you are, the 2021 deduction is now between $12,550 for a single filer under age 65 and $27,800 for joint filers over the age of 65. Therefore, if all your allowable deductions (including your charitable contribution) are less than this amount in a given tax year, you will not save any money in federal taxes by giving cash. In 2021, there is one exception to this that allows single filers to deduct up to $300 in charitable donations and joint filers to deduct up to $600, while taking the standard deduction.
The good news is, there are some options that can save you on taxes and allow you to direct more dollars to the non-profit close to your heart.
Qualified Charitable Distribution (QCD)
Once you reach age 72, you will be required to start distributing a certain percentage from your pre-tax retirement accounts, such as IRAs and 401(k) plans. These required distributions are taxable as ordinary income, unless they are given directly to a charity as a Qualified Charitable Distribution (QCD). This is an excellent strategy for many people, even when giving smaller amounts. By giving directly from your IRA, you eliminate taxes on the amount given (up to $100,000 annually) regardless of whether you itemize or take the standard deduction. Unlike other charitable deductions, QCDs also reduce your Adjusted Gross Income (AGI). This is important because your AGI is a factor in many other tax calculations, so reducing it can also reduce your Social Security taxes and Medicare premiums, increase your medical expense deductions, and help you qualify for certain tax credits.
To highlight the effectiveness of this strategy, here is an example of a couple who wants to donate $10,000
If you tend to give every year and your itemized deductions are close to the standard deduction amount, clustering your contributions can be very beneficial. For example, if you give $20,000 every year you might instead give $40,000 this year and nothing the following year. This would allow you to itemize in the year you donated $40,000 and take the standard deduction the following year. Even if you itemize, if your itemizations don’t exceed the standard deduction by the amount of your charitable contributions, clustering your contributions can increase your total deductions over a multiple year period. This strategy is particularly useful if you have unusually high income one year from the sale property, a business sale, a large bonus or vesting employee stock. If you are able to cluster your contributions using a cash donation, this year may be particularly beneficial for some people since the IRS has waived the usual 50% of income deduction limitation for 2021.
Donor Advised Fund
Many people want to take advantage of the clustering strategy, but feel an obligation to give to a certain organization every year, don’t want to give it all away at one time, or are not ready to decide which charities to donate to. In this case, using a Donor Advised Fund may be appropriate. These funds allow you to cluster several years of contributions for an immediate tax deduction and then to donate them over time. Until the funds are donated, they can be invested and grown tax deferred.
IRA Designated Funds
While the IRS does not allow QCDs from IRA accounts to Donor Advised Funds, you are permitted to make a QCD to a Designated Funds. Unlike Donor Advised Funds, Designated Funds have predetermined charitable beneficiaries, so they do not give you the flexibility to determine the organizations at a later date. They do offer an immediate tax deduction and allow for flexibility on the timing the organization receives the funds.
Donating Appreciated Assets
For anyone who owns appreciated assets outside of qualified retirement accounts, donating these assets without selling them first can be a great strategy. It’s particularly useful for people that have a highly concentrated stock positions and want to reduce their risk by selling some of the stock. I think seeing a simple example highlights the tax benefits best.
An Oregon couple purchases stock for $10,000. Years later the stock is worth $50,000.
If sold, they would have a $40,000 taxable gain. The couple has $200,000 of other taxable income, so they would owe 15% in Federal long-term capital gains taxes, 3.8% in Net Investment Income tax and 9.9% state income tax – totaling $11,480 in taxes. This reduces their donation and possible deduction to $38,520.
If they instead donate the stock directly, they avoid the federal and state taxes on the sale, the charity receives a larger donation, and they receive a larger deduction.
You can also incorporate charitable giving into your estate plan by naming a charity as a beneficiary on an investment account or in your trust or will. This is often utilized by people who want to leave a legacy behind. Since you receive a tax deduction on your estate taxes, this is a particularly good strategy for people who have a taxable estate and want to have access to funds during their lifetime.
When incorporating charitable giving into your estate plan, it’s important to consider how assets are taxed depending on who they are left to. For example: an IRA that is left to individuals will be taxable as ordinary income to your heirs, non-retirement accounts may receive a step-up in cost basis (basically forgiving the tax on investment gains) and Roth IRAs are passed tax-free. It’s therefore advisable to leave IRAs to charity and leave your non-retirement accounts and Roths to your friends and family.
For my fellow Oregonians, The Oregon Cultural Trust is an underutilized resource that can allow you to double your impact when donating to one of 1,400 different Oregon non-profits. You can see which organizations qualify on their website: www.culturaltrust.org. By making a matching donation of up to $500 per person you will effectively have your match refunded to you in the form of a tax credit, which reduces your tax due dollar for dollar. The matched amount is then granted to cultural nonprofits across Oregon. Residents of other states may have access to similar programs.
Charitable Gift Annuity
For people who need additional income a charitable gift annuity can be a good option to consider. In exchange for the donation, the charity provides an income stream for your life, or some other set period of time, and you receive an immediate partial tax deduction.
If you have significant assets that you would like to donate during your lifetime, you might also want to consider a charitable trust or a foundation.
Charitable trusts are irrevocable, so once assets are put into the trust you cannot use them for any reason not specifically outlined in the trust. The benefit is that you are able to donate appreciated property, receive an immediate tax deduction, and avoid capital gains on the sale. There are two main types. A Charitable Remainder Trust provides income to the charitable donor for life or some other specified period and at the end of the period the remaining assets go to the designated charity. A Charitable Lead Trust is the opposite. Income goes to the charity for a specified period and the remaining assets revert back to the donor or another named beneficiary. You will need an attorney to draw up the trust and having a professional trustee is often recommended, so this is best for more complex assets and larger donations. If this sounds appropriate for you, you may need to act fast. There is a tax proposal to tax the gains for the non-charitable portion of the trust, notably reducing the tax benefit of this type of donation.
A family foundation or private foundation can be appropriate for individuals who would like their charitable work to continue long after they are gone, by passing the torch to future generations. The donated funds are invested tax-deferred. Unlike other options you have the ability to hire staff, including your own family, to operate the foundation. Foundations are highly regulated and can be expensive to administer, so they are usually only pursued by families with significant assets.
Not all of these strategies will be appropriate for everyone and what makes sense for you one year may not be best the following year, so it’s important to work with your professional team on an ongoing basis. Talk with your financial planner about how this fits into your overall financial plan, to ensure you are balancing your generosity with your ability to achieve your other financial goals. Your planner can also help you narrow down your options, coordinate with your accountant and estate planning attorney, and consider options for taking advantage of higher deductions, such as Roth conversions or realizing investment gains in a lower tax bracket. If you are not currently working with a financial planner, you can learn about the advisors at Merriman at www.merriman.com/advisors.
Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax or legal or accounting advice, and nothing contained in these materials should be taken as such. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. As always please remember investing involves risk and possible loss of principal capital and past performance does not guarantee future returns; please seek advice from a licensed professional.
Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.
Wow—2020 was a year unlike any that we have ever experienced. In addition to a global pandemic, events throughout the year exposed many causes that need great support. At Merriman, we are about much more than just the numbers. We aim to have a deep understanding of our clients in order to help them incorporate their values in all aspects of their lives. This led to us having conversations with families about climate change, social issues dealing with race and gender, how to help neighbors and struggling communities, and how to make individual voices heard by large corporations and governments, amongst many other important topics. During the year, did you feel sad, confused, shocked, or overwhelmed by any of these? I know that I sure did, so you are not alone. There is hope, and you can take action in ways that you may not have previously considered. It doesn’t take a large financial or time commitment. You can incorporate your values and support causes through sustainable, responsible, and impact (SRI) investing. Equally important, you can implement an SRI strategy without having a negative impact on your investment returns or retirement goals. It may even lead to the opportunity for outperformance. I want to use this article to break down the barriers to sustainable investing.
It is helpful to first look at some data. In September 2019, Morgan Stanley conducted a study with 1,000 individual investors that they surveyed in two-year increments starting in 2015. Then they published the white paper Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice. I want to take a moment to highlight two graphs from that white paper:
Chart 1: Interest in Sustainable Investing
Source: Morgan Stanley, Sustainable Signals white paper, 2019.
Chart 2: Perceived Barriers to Adoption
Source: Morgan Stanley, Sustainable Signals white paper, 2019.
The first chart shows that there is a significant interest in sustainable investing, and that interest continues to grow. The second chart shows the perceived roadblocks that prevent investors from choosing sustainable funds. This explains why currently the actual implementation and use of sustainable funds is much lower than the interest levels show. Below are the reasons why those perceived barriers shouldn’t stop you.
I’d like to share a story to address the investment performance roadblock. In 2007, I went to Costa Rica as part of a school group called The Eco-Explorer’s Club. Our mission for the trip was to protect sea turtles from poachers and predators during the turtle’s nesting season. The trip was a success, and it was one of the greatest things I have ever been a part of. I remember being filled with so much joy that we had made a positive impact for the wildlife there and also for the wonderful people of Costa Rica. Tourism intended to support conservation efforts is a large part of their economy and provides many jobs. That is when I first made the connection that it is possible to simultaneously support planet and profit. The best of both worlds. Investment funds are able to achieve this as well, as companies increase their revenue by adopting sustainable practices, cutting costs, and listening to client demands.
The next roadblock is thought to be lack of investment products. That was true at one point in time, but it is no longer the case. There are hundreds of publicly traded mutual funds and ETFs available that thoroughly integrate environmental, social, and governance factors into their investment processes and/or pursue sustainability-related investment themes and/or seek measurable sustainable impact alongside financial returns. We are big fans of the DFA Sustainability Funds.
The third and fourth roadblocks go hand in hand. It is true that it requires time to understand sustainable investments and to stay current. That is why there are professionals such as us to help. You don’t need to do this alone. We are here and available to help you get the best plan in place. You can schedule a conversation directly on my calendar by clicking HERE.
After reading this article, I encourage you to click the link above for a virtual coffee chat or to forward this article to a friend who may be interested. Thank you.
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.
The Tax Cut and Jobs Act (TCJA) passed at the end of 2017, and the Setting Every Community Up for Retirement Enhancement Act (SECURE) passed at the end of 2019. These both made significant changes to annual tax-planning strategies.
The COVID-19 pandemic and the CARES Act relief package that followed created a new layer of complexity. Unfortunately, many taxpayers miss opportunities for significant tax savings.
Here are six moves to consider making before the end of the year to potentially lower your taxes both this year and in years to come.
Take the Standard Deduction Later. The new tax rules nearly doubled the standard deduction and eliminated many write-offs, limiting the benefit of itemizing deductions for most taxpayers. However, you can optimize your deductions by “bunching” itemized deductions in a single year to get over the standard deduction threshold and then by taking the standard deduction in the following year.
Example: Instead of giving $10,000 to charity annually (which will likely leave you with the standard deduction anyway), gift $50,000 every 5 years. This will give you a greater tax benefit in the first year while still claiming the standard deduction in the other years to maximize tax savings.
Pre-Pay Your Medical Expenses. Have major medical-related expenses coming up? You can potentially maximize the tax deduction by paying out-of-pocket medical expenses in a single calendar year—either by pushing payments out to the next year or pulling later expenses into this year.
A surprising number of medical expenses qualify, including unreimbursed doctor fees, long-term-care premiums, certain Medicare plans, and some home modifications.
Note: Medical expenses are an itemized deduction, so this strategy may be best used with the “bunching” strategy described above, including possibly paying medical expenses in a year you maximize charitable donations.
Give Money to Your Favorite Charity Right Now from Your IRA. If you’re over 70 ½, you can make up to $100,000 of annual Qualified Charitable Distributions (QCDs) directly from your IRA to a qualifying charity. Even better, for retirees who don’t need to take their Required Minimum Distribution (RMD) each year, these qualified charitable distributions count toward the RMD but don’t appear in taxable income.
Even though the CARES Act allowed RMDs to be skipped in 2020, you can still make a QCD this year.
Note: QCDs must be made by December 31 to count for this tax year.
Take Advantage of Years in a Lower Tax Bracket with a Roth Conversion. A Roth conversion can permanently lower your taxable income in retirement by converting tax-deferred assets (IRA / 401k) into tax-free assets in a Roth account. It is best to do this in years where you are in a lower tax bracket than you expect to be in the future.
Example: If a taxpayer at age 63 is in the 12% tax bracket, then moving $10,000 from an IRA to a Roth account will owe an additional $1,200 in taxes. That same taxpayer at age 73 may be in the 24% tax bracket due to Social Security, pension, and RMD income they didn’t have at 62. Taking that same $10,000 from an IRA will now result an in additional $2,400 in taxes.
Optimize Your Investment Portfolio to Improve Expected After-Tax Return. Prior to the TCJA, you could write off some fees you pay for investment management. The TCJA did away with that deduction. There are still ways to pay fees with pre-tax dollars that may make sense depending on the types of accounts used.
Likewise, some investments will be more tax efficient, and other investments will be less tax efficient. Where possible, move the most tax-efficient investments into a taxable investment account and the least tax-efficient investments into a tax-advantaged retirement account. The goal is to determine an ideal overall allocation, even if each individual account has a slightly different allocation.
Both strategies above can potentially help maximize the after-tax return on investments.
Optimize Your Retirement Contributions. The most important step you can take right now to reduce your taxes this year may be to review how and where you’re making retirement contributions. You may be missing out on critical tax savings (and investment growth) if you’re not optimizing your contributions.
Potential retirement account strategies people often miss include Solo 401k for self-employed individuals, backdoor Roth contributions, or “mega” backdoor Roth contributions at certain large employers.
Everyone’s situation is different, and today’s retirement environment is complex. Working with a financial professional who coordinates with your CPA can help ensure you’re not missing any opportunities to optimize your portfolio and pay less in taxes.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation.
Now we’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries. Here is our first of six installments on charitable giving.
In my estate plan, I’m planning to leave some of my assets to charity. What should I be mindful of with the passage of the SECURE Act?
Perhaps the largest consideration is which assets the charitable donation should be made from. While IRAs and other traditional retirement accounts have always been a good choice, the SECURE Act increases the value of using these accounts for charitable giving.
For an individual with traditional retirement accounts, Roth accounts, and taxable assets outside a retirement account wanting to give to charity from their estate, the preference would be:
Traditional IRA: Make charitable donations from here. Even if only part of the account is gifted to charity, the decreased remaining balance will reduce the taxable income the beneficiary realizes each year.
Roth IRA: Leave these to individuals instead of charities. Even though Roth IRAs still have annual RMD, the income removed from a Roth account will not be taxable for the beneficiary.
Taxable Accounts: Individuals should be preferred over charities. There is no requirement to take income in a given year, and the beneficiary likely received a step-up in cost basis, minimizing the tax impact when used.
If your goal is to both leave money to charity and create an annual stream of income for a beneficiary that lasts longer than the 10-year rule for new inherited IRAs, a charitable remainder trust may accomplish these goals.
As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.
Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.
By reporting QCD’s correctly on your tax return, you rightfully receive the benefit of income exclusion.
Form 1099-R is issued around tax time to report distributions you withdrew during the previous year from a retirement account. A few of the things this form tells you and the IRS are: how much was withdrawn in total, how much of the distribution was taxable and whether there were any withholdings for federal and state income taxes.
If you gave part or all of your required minimum distribution directly to charity through making a QCD (qualified charitable distribution), this amount is still included in the taxable portion of your total distribution on form 1099-R. As you’ll see, the QCD is included in your gross distribution (box 1) and taxable amount (box 2a). However, the box for “taxable amount not determined” (box 2b) will be checked. Whether you work with a professional tax preparer, use software like TurboTax or prepare your own taxes by hand, it can be easy to forget that the QCD portion of your distribution should not be included on your tax return as taxable income. It’s important to keep a record of every QCD made during the year, and hold on to any correspondence that you receive from the charities that confirms the receipt of funds.
Below is a blank version of the 1099-R available on the IRS website.
This is a copy of a 1099-R issued by TD Ameritrade.
In this first example, the individual had a $70,000.00 gross (line 1) and taxable distribution (line 2a). The box next to “taxable amount not determined” (line 2b) is checked. Federal income tax of $8,000.00 was withheld (line 4). The distribution was considered a “normal distribution” because the distribution code 7 was used (line 7). What this 1099-R doesn’t tell you is that $20,000 of this individual’s RMD was a QCD, while the remaining $50,000 of the withdrawal was taxable.
As shown below, you should put the information from the 1099-R on the first page of your tax return (Form 1040) on line 4a and 4b. Here the individual had a total IRA distribution of $70,000. Of this distribution, $20,000 was a QCD. This means that the QCD won’t be included in the taxable income. If there is the option to do so, write “QCD” to the left of box 4b on your tax return. Here you would need to add the $8,000 federal income tax withheld from this IRA distribution to any other federal withholdings from W-2s and/or 1099s for the year on line 17 (page 2) of your tax return.
Remember to file IRS Form 8606 Nondeductible IRAs if you had basis (after-tax contributions) in the Traditional IRA from which you made the QCD, and took a regular distribution. You must also file this form if you made a QCD from your Roth IRA. However, we would not suggest making a QCD from a Roth IRA since the account is after-tax versus pre-tax.
The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. The specific example provided is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Investors should consult with a tax professional to ensure all their tax paperwork is accurately filed.