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The pandemic sparked charitable giving among wealthy families, and some who are eager to give more may score a bigger 2021 write-off by leveraging money from pretax retirement accounts.
Here’s how it works: Certain retirees with excess pretax retirement savings — meaning they’ve saved more than they expect they’ll need — may withdraw the funds and donate the cash to a qualified charity. There are taxes on the distribution, but retirees may offset some levies with a higher charitable deduction.
Donors may claim a tax break of up to 100% of their adjusted gross income for cash donations in 2021, a CARES Act measure meant to boost charitable giving during the pandemic.
However, they must itemize deductions to claim the write-off, meaning their total tax breaks exceed the standard deduction, which is $12,550 for individuals and $25,100 for married couples filing together for 2021.
Moreover, the strategy makes sense only for certain retirees, financial experts say.
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“First of all, you have to be charitably inclined,” said JoAnn May, a certified financial planner and CPA with Forest Asset Management in Berwyn, Illinois.
Tax incentives aren’t the prime motivation for most wealthy donors, according to a Bank of America study on high-net-worth philanthropy. Still, those looking to give typically prefer tax-efficient ways to transfer the money.
One option, so-called qualified charitable distributions, allow tax-free transfers from an individual retirement account of up to $100,000 per year. This withdrawal may also count as the retiree’s annual required minimum distribution.
However, taxpayers must be at least age 70½ to make qualified charitable distributions, and donations of more than $100,000 per year won’t qualify for tax-free treatment.
People ages 59½ to 70½ and those over 70½ who want to donate more than $100,000 in 2021 may benefit from taking the money from another pretax retirement account.
Retirees need to know how more income may affect their entire tax situation, said David Foster, CFP and founder of Gateway Wealth Management in St. Louis.
“You might screw up some of the other deductions,” he said.
For example, if someone’s adjusted gross income is $100,000 and they itemize deductions, they may claim a write-off for qualified medical expenses above 7.5% of their AGI. So with $10,000 in expenses, they may deduct $2,500.
There are so many unintended consequences when you start changing adjusted gross income.
Principal at Forest Asset Management
However, bumping up AGI with retirement plan distributions may eliminate that deduction, Foster said.
Increasing income may also affect the cost of Medicare premiums. Although most retirees don’t pay for Medicare Part A, the price for Medicare Part B may jump based on income, with top earners paying $504.90 per month in 2021.
“I think there’s nothing like running the numbers,” said May. “There are so many unintended consequences when you start changing adjusted gross income.”
These gifting tactics may pay off for a limited number of individuals, Foster said.
The strategy may work for someone planning to make a significant charitable gift in 2021. For example, it may be appealing to a philanthropic retiree with excess money in pretax retirement accounts.
“All you’re doing is accelerating future income into the present,” Foster said.
Someone must be at least 59½ to avoid early withdrawal penalties. But if they are still under 70½, they may use other retirement account funds because they aren’t yet eligible for qualified charitable distributions from an IRA.
It may also make sense if they are over 70½ and want to donate more than their $100,000 qualified charitable distribution from an IRA.
Of course, retirees need to see how the extra income affects their tax situation, Foster said.
But someone who checks all the boxes may benefit from the bigger charitable deduction for cash in 2021. Plus, they can remove money from pretax retirement accounts, their least tax-friendly source of future income, he added.