Insights for Your Journey

If you’ve worked hard and planned well, you’re likely to accumulate more wealth than you’ll need in your lifetime. You might also feel like that annual income tax bill is growing ever larger, before even considering the future impact of estate taxes.

Giving to charity helps with taxes in two ways:

  1. It provides an income tax deduction today, offsetting taxes on other income.
  2. It moves assets out of your estate, reducing future estate taxes that take a bite out of the legacy you plan to leave. You can use our calculator to find out if you’re exposed to estate taxes.

If you are looking to reduce taxes and increase your overall impact, this brings up an important question:

Who do you want to leave the remainder to?

As we discuss in Planning by Default vs. Planning by Design, your three basic options are the government through taxes, loved ones, and charity. The government has a default plan in place for taxes you’ll pay and who will receive the remainder, leaving zero to charity. Your success also often brings big income and estate tax bills. If you’re charitably minded, this brings a second important question:

What can you do to reduce these taxes and include the causes you care about in your legacy?

 

Giving to charity – common first steps.

To begin to accomplish this you might consider giving to these causes today. You might even include your favorite charities in your wills. Whether you give today or tomorrow, this simple step ensures that charity benefits from your wealth. It also helps reduce a potential estate tax bill.

So…what’s the problem?

We’ve often found this is an incomplete solution for two reasons:

  1. If the unexpected strikes and you need these funds in the future, they are gone forever.
  2. If you’re facing large income tax bills, you could be leaving hundreds of thousands of dollars in tax savings on the table.

Fortunately, there are strategies you can use to make big impact on the causes you care about, save more in taxes, and even keep access to some of the funds. Here are three ideas:

1. Keep it simple and leave pre-tax retirement accounts to charity.

Which of your assets get hit hardest by taxes? It’s likely your pre-tax retirement accounts. You pay income tax when you withdraw these funds and, when left to your family, they are subject to both income and estate taxes. However, you can easily correct this, often online in less than five minutes, saving thousands in future income and estate tax.

Spend from low or no tax accounts like Roths and brokerage accounts to fund your lifestyle. Then, make your favorite charity the contingent beneficiary on your pre-tax IRA, 401k, and other retirement accounts. You maintain access to these funds during your lifetime and transfer these high tax funds to charity when you’re gone, avoiding every penny of tax because your qualified charity doesn’t pay those taxes.

See Which Assets Should I Spend and Which Should I Pass On? for more.

2. Fund a Credit Shelter Trust at your death and leave the rest to charity.

Washington State charges an estate tax on assets above a $2.193 million exemption, in addition to federal income and estate taxes you might owe. A Credit Shelter Trust is funded at your death, passing your tax-free amount up to $2.193 million to a trust at your death. These funds are available to your spouse for his or her lifetime, then pass to your chosen beneficiary at the second death.

If you leave everything else to charity at the second death, you’ve maintained access to your assets during your life and eliminated all estate taxes. However, depending on the size of your estate, this may give more to charity and less to family than you would like. If so, the next strategy is for you.

3. Move assets out of your estate today and maximize tax savings.

This takes more effort but is well worth it. You’ll need to design a comprehensive financial plan, including three buckets:

  • A – Assets you need. This is your nest egg, the source of income you need to enjoy life. Carefully calculate this, including room for the unexpected, to ensure you don’t run out of money.
  • B – Assets that you probably won’t need. Your “A” assets are more than likely to take care of you, but you should still have access to this bucket just in case.
  • C – Assets unquestionably dedicated to charity and loved ones. With well stocked “A” and “B” buckets, you can confidently give up access to these funds to reduce taxes and increase your overall impact.

Once your A and B buckets are in place, you can ramp up your income and estate tax savings by transitioning your C assets out of your estate today. Here are a few ways:

  • Fund a Donor Advised Fund in a high-income year. This charitable giving account provides a tax deduction in the year you make the contribution and flexibility to make gifts to charity over any time period you choose.
  • Make gifts to charity today. Raise the paddle at highest level at the charity auction. These donations generally reduce income tax today and you get the added benefit of seeing these gifts in action during your life!
  • Make Qualified Charitable Distribution with your next Required Minimum Distribution. If you’re 72 or older, you’re required to take annual distributions from pre-tax retirement accounts. Use this strategy to save taxes by giving that distribution to charity instead.

 

But wait…there’s more! Let’s revisit your B assets.

We’ve designated assets you probably won’t need but would like to keep access to – your B assets. You can begin transitioning these assets out of your estate, while increasing tax savings and maintain some level of income or access. How?

  • Fund a Charitable Remainder Trust. You’ll get a tax-deduction today, annual income payments, and leave the remainder to charity when you pass.
  • Fund a Wealth Replacement Trust. You’ve just made a substantial gift to charity, leaving less to your family. With annual gifts to an Irrevocable Life Insurance Trust for your family, you replace the gift you just made to charity and increase the overall pie. Rather than giving a lump sum all at once, you make annual contributions instead that fund a death benefit for your family when you pass.

For a more thorough discussion on strategies with your B assets, see Out of Your Estate, Not Out of Reach.

With a well-crafted plan you may be able to decrease income taxes while you’re alive, increase the impact on the charities that you care about, and reduce or eliminate the estate taxes due when you’re gone.  That is a win-win-win.

Not sure where to start? Complex problems require a team approach…a conversation with a planning team like Alterra is a great first step.

Zach Hamilton

Financial Advisor

About the Author

Zach graduated from Gonzaga University with degrees in Marketing and Finance. While growing up, Zach heard stories from his grandfather about his work as an insurance agent, and other stories from his dad who was an investment manager. They both spoke financial “languages” but had completely different dialects. Recognizing the breadth of the financial vocabulary ultimately led to Zach’s passion for financial planning. He credits his family for this enthusiasm. Zach sees his time with clients as an opportunity to translate all of the different – and often confusing – information they’ve heard and provide clear guidance for each unique situation.

Zach enjoys working with people – his clients – who also appreciate that their financial decisions have an impact not just on themselves, but also on their families, charities and their own life legacy. Many of Zach’s clients have a strong desire to “make a difference”, and they rely on his financial expertise to magnify their philanthropic goals.

The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.

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