Charitable giving can be good for your conscience as well as your finances. The substantial tax breaks associated with those gifts play an important role in tax and estate planning, even with today’s generous federal estate tax exemption of $12.06 million.
That exemption has reduced the urgency of making charitable donations, says Patrick Simasko, an elder law attorney at Simasko Law in Mount Clemens, Mich “In the good old days for charities, during the ’90s, you could only pass [along] $600,000 to your kids tax-free before the federal estate tax kicked in. Many clients, especially if they have kids, have the attitude that charity begins at home.”
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Still, the current federal exemption expires in 2026, when it could fall nearly 50% unless Congress acts. Plus, 17 states and Washington, D.C., charge an estate or inheritance tax that kicks in at much lower limits. Your donation could also get you an income tax deduction today that can be used to offset high-tax events like selling a business or making a Roth IRA conversion. Some strategies can even generate future retirement income for you, all while giving urgently needed money to a cause you care about.
If you plan on donating part of your net worth to charity, several methods give you more tax, income and estate-planning benefits than simply writing a check.
Here are the best options to consider based on your goals, net worth or needs.
Qualified Charitable Distributions
Best for someone who does not need their required minimum distribution. This is one of the easiest ways to give to charity, but you must be at least age 70½ to do it. A qualified charitable distribution lets you transfer up to $100,000 per year directly to charity tax-free from an IRA. The QCD can be used to satisfy a required minimum distribution that you may not need but must begin taking at age 72.
If your RMD is $10,000, Simasko says, “you can just direct that $10,000 to go directly to charity so you don’t have to pick it up as income on your tax return.” A QCD also spends down your IRA, which is not as tax effective for heirs, who will owe tax on the entire account balance when it’s withdrawn. The charity, meanwhile, gets the money right away.
QCDs are only allowed for IRAs, not 401(k)s. If you have pre-tax money in a 401(k) and want to use this strategy for future RMDs, you must roll over the balance into a traditional IRA first. QCDs also can disqualify you from Medicaid in the near future. “The government has a five-year lookback for money given away from the date you apply for benefits,” Simasko warns. If you later spend down your assets to pay for a nursing home and then want help from Medicaid, your donation will postpone your eligibility.
Best for maximizing tax impact with a delayed charitable gift. Generous standard deductions—$12,950 for individuals and $25,900 for married couples filing jointly in 2022— discourage charitable giving. (The standard deduction is even more generous for people 65 and older who can claim an additional $1,400 in 2022.) Unless your charitable gift helps you go over that amount so that you can itemize, you won’t get any tax benefit from the donation.
With a donor-advised fund, you make a large donation all at once, instead of many small ones over time, to push you over the standard deduction and maximize the tax impact of your gift. You get an upfront tax deduction, but the full donation can be delayed. “It’s particularly useful if you have a large, one-time taxable event, like you just sold a business,” says Bruce Tannahill, director of estate and business planning for MassMutual. “You get the deduction when you have the high income but can spread donations over time.”
Foundations, universities, philanthropic service companies and major brokerage firms like Fidelity and Vanguard can help you set up a donor-advised fund using cash, stock or other capital assets. The gift is irreversible so you can’t get the assets back.
How much you can deduct at once depends on your adjusted gross income and the type of gift. If you give cash, you can only deduct up to 60% of your AGI for the year. That limit is 30% of AGI for donating capital assets like appreciated stocks. If your gift exceeds these limits, any unused deduction can be claimed against future taxes for up to five years, says Neil V. Carbone, trusts and estates partner at Farrell Fritz in New York.
You retain control over the funds, choosing how to invest the money in the donor-advised fund, with the gains going to charity. You also determine which charities to support and when to make donations. “The fund isn’t obligated to listen, but unless there are specific reasons why they can’t fulfill your request, they usually do,” says Carbone.
The charity must be in good standing with the IRS and some charity-based donor-advised funds may add their own restrictions—for instance, a university fund may require that part of the total donation goes to the school. If you die before the money is spent, it is doled out according to your instructions, or a successor that you named takes over.
Although simpler and cheaper than setting up a private foundation or trust fund, donor-advised funds come with fees. Vanguard and Fidelity, for example, charge about 0.6% per year in maintenance fees, reducing them for accounts over $500,000. Smaller organizations may charge higher annual fees of about 1%. This is on top of the investment funds’ annual fees.
Charitable Gift Annuities
Best for someone who prioritizes a predictable income. Your charitable gift can also generate retirement income for you from the donated assets. One option is a charitable gift annuity. After you make a single lump sum donation, the charity sets up an annuity contract.
“It’s like getting a pension,” says Simasko. “They’ll pay you a fixed, predictable income stream for the rest of your life. Once you die, anything leftover stays with the charity.” The amount of income depends on the charity, the size of your gift and your age—the older you are, the higher the payment. Tannahill says that charities typically pay the same rates, using those recommended by the American Council of Gift Annuities. “That way organizations are competing for donors based on what they offer as a charity, not what they pay for annuities,”
he says. For example, if you’re 65, the current rate is 4.2%, and a $100,000 donation generates $4,200 in annual income for the rest of your life.
Because you forfeit some annuity income, the IRS gives you an upfront deduction worth the estimated present value of all the missed payments over your expected lifetime. The charity or a tax adviser can calculate the total deduction before you make the donation, which can be a variety of assets, but don’t use retirement account money as that counts as a withdrawal, with income tax owed on the gift before it’s donated.
How your annuity income is taxed depends on how you made the donation. For a cash gift, income up to the return of your principal is tax-free while earnings from the annuity contract are taxed as ordinary income. For appreciated capital assets like stock or real estate held for more than a year, part of your income also qualifies for the lower long-term capital gains tax rates.
Tannahill says this is a safe, predictable income stream that the charity is legally obligated to pay. “The payment can be made from any of the charity’s assets, not just what you donated. If you give stock that falls in value, the charity still needs to make your annuity payment from their other funds.”
Simasko says charitable gift annuities are also quick and inexpensive to create. “The charity will give you a contract to fill out, and you transfer the assets. That’s it. You don’t need a lawyer.” That simplicity comes at the cost of flexibility. These annuities lack inflation protection, and once you set up the contract, you can’t get your money back or change the annual payment.
The gift annuity must be with only one charity, and not all offer gift annuities. “They’re usually available only at the large, established charities,” says Tannahill.
Charitable Remainder Trusts
Best for making a large donation, at least six figures, in exchange for more flexibility and an income. To support multiple charities while generating some retirement income, you’ll want a charitable remainder trust. Once it’s funded, the donor receives payments—between 5% and 50% of the trust balance annually—for a set number of years or for life. Whatever remains at the end of the payout term goes to charity, but it must be at least 10% of the original donation.
You receive an upfront deduction for your estimated future gift, which a tax professional can determine for you. The smaller the annual income percentage you receive, the larger your deduction.
Tannahill notes that if the charity doesn’t get the full 10%, perhaps because of, say, poor investment performance, the IRS will let you keep your deduction provided the original projection was calculated according to IRS standards. If the deduction is large, use it to offset the taxes for converting a traditional IRA to a Roth, says Dan Casey, founder of Bridgeriver Advisors in Bloomfield Hills, Mich.
There are two types of charitable remainder trusts: a charitable remainder unitrust and a charitable remainder annuity trust. With the unitrust, your income will vary each year depending on the trust balance, and you can postpone or change the choice of charity or even contribute more money later. The annuity trust gives you more predictability at the expense of flexibility, with fixed payments that won’t fluctuate, but you can’t add to your contribution.
No matter which type of charitable remainder trust, only a portion of the distribution is tax-free as it can fall into four categories—ordinary income, capital gains, tax-exempt income and return of principal. The IRS assumes that 100% of your payments come from the highest possible tax group until that balance is exhausted. Then the income is drawn from the next highest tax category.
Setup costs range between $3,000 and $8,000, depending on the trust’s complexity, Casey says. Ongoing administrative fees are usually a percentage of the trust assets, and income taxes for a unitrust could be higher, especially during the first few years, because of the way the trust distributes income and assets.
Best for high-net-worth individuals donating $500,000 or more. “A charitable lead trust is the mirror image of a charitable remainder trust,” says Carbone. Instead of the money coming to you first, the trust makes annual payments to one or more charities, and at the end of a set term that you pick, whatever is leftover goes to you or or another family member. The charitable payout term can be as long as you want.
As with a charitable remainder unitrust, you pick the percentage of the trust balance to be paid to charity each year. Your deduction is based on the present value of these future payments. Because the payment is a percentage of the balance, it can fluctuate each year depending on how the underlying investments perform. (An annuity version of a charitable lead trust creates fixed annual payments for the charity.)
In exchange, you get an upfront deduction, can see how the charity uses your donation, and still leave money for heirs. You also have the flexibility to change charities after setting up a charitable lead trust.
But you cannot access that wealth during the trust payout period. These trusts are also expensive. Carbone says they cost $5,000 to $7,000 to set up, and trust and administrative fees run several hundred to several thousand dollars per year. That’s why he recommends these trusts only for donations of $500,000 or more. Rising interest rates also don’t favor these trusts.
Best for playing it safe with your estate plan. Don’t overlook the most obvious charitable-giving tool — your will. You retain control of your assets while alive and designate charities to inherit specific assets after your death. Those posthumous donations can reduce estate and inheritance taxes for your heirs and don’t count toward the lifetime estate and gift tax exemption.
The money can be divided between charity and your heirs however you want, but Simasko recommends making the charity the beneficiary of IRAs or 401(k)s funded with pre-tax dollars. “Rather than splitting your entire estate 50/50, I would give the retirement accounts to charity and leave the house and other assets to your family,” he says.
Apart from drafting a will, which you need to do anyway, there aren’t any extra costs associated with this charitable-giving strategy. The downside is you won’t receive any tax deductions during your lifetime, and the charity won’t get anything until after you die, which could be many years away.
But you do get to play it safe with your estate plan. “For some people, it doesn’t matter how many simulations they see from an adviser saying they could safely get by on just 70% of their remaining savings,” Simasko says. “They still want to keep the full amount just in case.
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