With the arrival of Thanksgiving comes the start of the peak season for giving to charity, and Americans may well set another record in 2016, as they do most years. In 2015, Americans gave a record $373.25 billion, up from $358.38 billion the year before.
This year most of the guidelines are familiar: Give to a cause you really care about; be wary of solicitations by phone and email; check out the charity with a service like Charity Navigator or Guidestar; keep records so you can get the tax deduction you're due come April.
But there is something new. Last December, Congress and President Obama made permanent a tax law on qualified charitable distributions (QCDs) that allows individuals 70 ½ or older to give directly from their IRAs rather than having to take a distribution that would trigger an income-tax bill. The rules allow you to save on taxes and, as a result, give more if you want. Because a QCD reduces income and is not an itemized deduction, it even benefits investors who do not itemize.
"The biggest change for 2016 is that we don't have to wait for or wonder if the rules are going to change in the near future, as they did in '08, '10, '12, '14 and '15, when the QCD lapsed and was reinstated under a half-dozen pieces of different legislation," explains Jeff Weeks of ATX Portfolio Advisors in Austin, Texas.
Previously, Congress extended this rule year by year, often waiting so late that givers were left in confusion. This year there's time to consider how giving from an IRA can reduce or eliminate your need to take the hated required minimum distribution (RMD) faced by investors 70 ½ or older.
With permanence comes the opportunity to make giving from your IRA part of a long-term plan. And that raises questions about figuring how much you can give while leaving a safety net for yourself and a spouse, providing an inheritance for children and properly managing a portfolio that contains ordinary taxable investments as well.
The law on qualified charitable distributions (QCDs) covers people 70 ½ or older and is thus subject to the RMD requirement to begin annual IRA withdrawals based on your life expectancy — 1/20th of the account, for example, for one expected to live another 20 years, according to government tables. With a QCD, these investors can give up to $100,000 a year to charity, allowing most people to cover the entire RMD.
To be tax free, the donation must go directly from the account to the charity without passing through the investor's hands. A $10,000 donation could thus escape $2,500 in income tax, assuming a 25 percent tax bracket, and the investor could therefore give the entire $10,000 rather than $7,500 if some had to be held back for taxes.
By not taking the RMD or selling IRA holdings to raise cash for charity, the investor avoids an income increase that could lift his or her tax bracket. Keeping income down by avoiding an IRA distribution can also reduce the portion of your Social Security benefit that is taxed and help avoid the Medicare surcharge on high incomes. A QCD benefits investors who prefer not to itemize deductions, because their standard deduction is bigger.
"The beauty behind the qualified charitable distribution is that it's not a deduction, but, rather, the IRA distribution is excluded from gross income," says Sarah Rebosa a tax specialist and partner in Cullen and Dykman, a Garden City, New York, law firm. "Therefore, individuals who wouldn't otherwise be entitled to a charitable deduction — taxpayers who take the standard deduction — can now obtain a tax benefit from contributing to charities."
The bank, brokerage or fund company that has your account can walk you through the process. Some IRA administrators even provide checks for charitable donations, assuring you will have proper records if the IRS comes calling. (If you don't have this option, contact the charity before donating to get proper credit and paperwork. Otherwise, they may only show the donation as coming from your account administrator.)
Maximizing any tax benefit requires a crystal ball, since it depends on future income and expenses, tax rates and rules that may change over time. But experts do have some advice based on today's rules.
The ability to reduce IRA holdings through QCDs, for example, can make it unwise to convert a traditional IRA into a Roth IRA, says Weeks. That's because you must pay tax on converted assets, and it would not make sense to convert, pay tax and then withdraw from the Roth for charity if you could donate with no tax bill with a QCD, he explains.
For most investors, the first issue, of course, is how much one can afford to give while reserving enough to meet the unexpected.
"I have worked with clients that give more than they can safely give, for a variety of reasons. It is not my job to impose my values on them but to lay out various scenarios and outcomes if they are making an emotional decision over a financially sound decision," says Libby Muldowney, an advisor with Savant Capital management, based in Rockford, Illinois.
Before giving, an investor "needs to understand the big picture of the gift and how it will impact their financial stability if it is outside reasonable guidelines," she says.
In devising a long-term giving strategy, investors should also think about how their heirs will fare, says Thomas Walsh, a planner and portfolio manager with Palisades Hudson Financial Group's Atlanta office.
A young heir may be better off in the long run by inheriting an IRA rather than an equal sum in cash, he says, because the heir can stretch withdrawals from the IRA over a lifetime, getting tax deferral on additional gains for many years. Gains from investing a cash inheritance could be taxed more frequently, eroding the nest egg.
"If making sure individual heirs receive the maximum benefit is important, it is worth considering other vehicles for your charitable giving," Walsh says. In some cases, it may be best to keep the IRA and give from other funds, he says.
Investors should also think about timing, he says, giving the most when they're in a higher bracket so they can benefit from reducing their income. For example, years they realize big gains on taxable investments or have fewer deductions.
It also can pay to know the tax situation of prospective heirs, says Muldowney, explaining that it generally works best for a parent in a high tax bracket to defer taxes and leave an IRA to a child in a low bracket, since the eventual tax bite will be smaller for the child. This could influence the decision about whether to spend down an IRA through QCDs or to leave the account to a child and give to charity another way.
In some cases, making a qualified charitable distribution may not be as financially beneficial as giving charity an appreciated asset, like a stock from a taxable account, a move that avoids capital gains tax, Walsh says. The bigger the gain, the greater the tax saving from giving the appreciated holding. So this would determine whether it's best to give from the IRA or the taxable account.
For the sake of family harmony, Muldowney recommends talking with prospective heirs about any substantial charitable giving. "Make the decision, implement it and then discuss," she suggests. "This avoids you giving the impression that it is up for debate."
— By Jeff Brown, special to CNBC.com