In Part one of this series we discussed the fact that retirement income is different than employment income. Retirement income tends to be more flexible and gives you more control over when you pay taxes and how much you pay in income taxes.
The strategies discussed in the first article had to do with filling up your tax brackets by selling appreciated assets in a taxable account or with Roth conversions. Implementing the strategies can help you pay considerably lower taxes over your lifetime among other advantages.
Another important way to lower your taxes is to strategically give to charities. Charitable giving is a part of many people’s annual budget, but there are specific ways to give that can be more tax-advantaged than others.
The default way of charitable giving is out of cash flow. Gifting out of cash flow may or may not allow you to take a deduction when you file. Unfortunately, the implementation of the Tax Cut and Jobs Act in 2017 forced many federal employees and retirees to switch from itemizing their taxes to taking the standard deduction.
But in order to itemize, one would need the following deductions combined to be above $25,100 for married filing jointly, or $12,550 for single persons:
- Mortgage interest
- SALT taxes – state and local taxes such as income tax and real estate taxes.
- Charitable giving
Many couples will have their mortgage paid off by the time they get to retirement and SALT taxes are capped at $10,000, which makes it hard to have deductions above the $25,100 standard deduction.
Donating Appreciated Assets
A way to still get tax benefits from charitable giving, then, is by donating NOT IN CASH, but in the form of appreciated stocks, mutual funds, or ETFs. Here is an example of how it would work:
Joe Federal has a mutual fund in his brokerage account that has grown from $3,000 to $9,000. If Joe donates the $9,000 to a charity, he won’t have to pay taxes on the gain of $6,000 and neither will the charity. At a 15% capital gains rate, Joe will avoid paying $900 in taxes.
Keep in mind, the investment must be held for twelve months in order to avoid paying taxes on the gift. Joe can still deduct the gift as well, so if he does have enough deductions to itemize, he can still deduct the full amount of the gift.
Qualified Charitable Distribution
Another way to give more efficiently is to do it out of an IRA. This is called a Qualified Charitable Distribution (QCD). Once a person reaches age 701/2 they can gift out of an IRA and not pay income taxes on the distribution. The gift has to go directly to the charity from the IRA custodian, but this is pretty simple to set up.
Luckily, the QCD can also count as a person’s Required Minimum Distribution (RMD). It’s pretty common for retirees to reach the age of 72 and not need to take their full RMD. Qualified Charitable Distributions are a great way to save tax dollars on charitable gifts as well is reduce your RMD. If you want your QCD to count toward your RMD then it should be done at the beginning of the year, or before other distributions are taken.
Can a QCD be done from the Thrift Savings Plan? No, TSP does not allow QCDs. If QCDs appeal to you then you will want to transfer your TSP to an IRA to take advantage of QCDs.
The end of the year is an excellent time to see where you can manage your overall personal finances and reduce your 2021 tax bill. Charitable giving is another element of financial planning that we assist clients with. If you are interested in becoming a client you are welcome to schedule an introductory call.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.