For many retirees, charitable giving is a meaningful way to support causes they care about while potentially reducing their tax burdens. However, with recent changes in tax laws and deduction thresholds, some retirees may find their charitable contributions don’t provide the tax benefits they once expected. This shift is largely due to the increased standard deduction, which has made itemizing less common and can limit the impact of charitable deductions for many taxpayers.
Choosing between the standard deduction and itemized deductions on your tax return is a crucial first step in understanding how to maximize your charitable giving. This article will guide you through the differences between these options, explore what has changed to make it so many are not receiving tax benefits from charitable contributions, and highlight strategies—such as using a Donor-Advised Fund (DAF)—that can help increase your tax efficiency.
Understanding the Standard Deduction vs. Itemized Deductions
When filing your taxes, you can reduce your taxable income by choosing either the standard deduction or itemizing your deductions. Here’s how each option works:
Standard Deduction:
The standard deduction is a fixed amount that reduces your taxable income, simplifying the tax-filing process by eliminating the need to track individual deductible expenses. For the 2024 tax year, the standard deduction amounts are:
- Single filers: $14,600
- Married filing jointly: $29,200
- Head of household: $21,900
Additional Standard Deduction for Individuals 65 and Older:
If you’re 65 or older, you are eligible for an additional standard deduction:
- Single or head of household: An extra $1,950
- Married filing jointly: An extra $1,550 per qualifying individual
For example, a married couple filing jointly, both aged 65 or older, would have a total standard deduction of $32,300 ($29,200 + $1,550 + $1,550).
Itemized Deductions:
Itemizing allows you to deduct specific expenses from your taxable income. Common itemized deductions include:
- Medical and Dental Expenses: Unreimbursed expenses exceeding 7.5% of your adjusted gross income (AGI).
- State and Local Taxes (SALT): The total deduction for state and local income, sales, and property taxes is capped at $10,000.
- Mortgage Interest: Interest paid on mortgage debt up to $750,000.
- Charitable Contributions: Donations to qualified charitable organizations.
To benefit from itemizing, your total eligible expenses have to exceed the standard deduction for your filing status. If you understand this concept, then you can see how a lot of people are not receiving tax benefits from their charitable contributions.
What has Changed?
- Higher Standard Deduction (Expanded by the TCJA): The Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction, greatly reducing the number of taxpayers who benefit from itemizing. As a result, more people now take the standard deduction, which has limited the tax benefits of charitable contributions for many.
- Lower Mortgage Interest Deductions: Mortgage interest is one of the primary deductible expenses when itemizing. However, with many households refinancing at lower rates in 2020, 2021, and 2022, the amount of deductible mortgage interest has declined. Many retirees have also paid off their mortgages or are primarily paying down the principal, leaving less interest to deduct.
- SALT Deduction Cap: State and local tax (SALT) deductions are now capped at $10,000, which can limit itemizing benefits for those in high-tax states. This cap makes it challenging for residents in these areas to reach a total deduction amount that exceeds the standard deduction.
Bunching Donations Using a Donor-Advised Fund (DAF)
A Donor-Advised Fund (DAF) operates similarly to having your own personal private foundation, but with fewer administrative requirements. It acts as a “middleman” between you and the charity, allowing you to make strategic contributions with tax efficiency. Here’s how it works:
By “bunching” several years’ worth of charitable donations into a single year and contributing that larger amount to a DAF, you can itemize in that year and potentially exceed the standard deduction, resulting in significant tax savings. Once the funds are in the DAF, you retain control over how and when they are distributed to qualified 501(c)(3) charities, allowing you to make regular donations over time.
While you retain control over the timing and allocation of donations, the contribution to the DAF is irrevocable—meaning the funds must eventually be directed to a qualified charity. However, within the DAF, your donations can grow tax-free through investments, which could further increase the amount available for giving.
This approach allows you to manage your charitable giving in a more strategic way, similar to a private foundation, with the DAF acting as an intermediary that helps you achieve consistent, tax-efficient support for your chosen causes.
Considerations
When planning charitable contributions, timing and strategy can make a substantial difference in maximizing your tax benefits. Here are some key considerations:
- Donating Appreciated Securities
- Donating appreciated securities (like stocks, bonds, or mutual funds that have increased in value since you bought them) to a Donor-Advised Fund (DAF) offers a double tax benefit. Let’s say you bought stock years ago for $10,000, and today it’s worth $20,000. If you sell it, you’d typically owe capital gains tax on the $10,000 appreciation. However, if you donate the stock directly to a DAF, you avoid paying capital gains tax, and you get a charitable deduction for the full market value of $20,000.
- This approach lets you save in two ways: (1) you avoid capital gains tax on the appreciation, and (2) you receive a tax deduction for the full market value, providing you with a more powerful charitable deduction without dipping into cash reserves.
- You Must Be Charitably Inclined: A DAF is best suited for those who genuinely want to support charitable causes. Contributions to a DAF are irrevocable, meaning that once you donate, the funds must eventually go to qualified charities.
- Most Effective in High-Income Tax Years: The tax benefits of donating to a DAF are amplified if you’re in a higher income tax bracket. For example, if you’re in a 40% marginal tax bracket, you save $0.40 on each additional $1 deduction, meaning a $10,000 deduction saves you $4,000 in taxes. In contrast, someone in a 10% bracket would save only $0.10 per dollar, or $1,000 on the same donation. For those with higher taxable income, the deduction’s impact is more significant, maximizing the tax savings in a high-income year.
- The DAF Is Irrevocable and Limits Liquidity, Despite Giving You Control: While you retain control over the timing and choice of charitable recipients, DAF contributions are irrevocable. This means once you donate, you can’t withdraw funds for personal use—they must eventually be directed to a 501(c)(3) charity. For this reason, contributions to a DAF may create some illiquidity in your portfolio, so it’s essential to consider this in your overall financial plan.
- Pairing Roth Conversions with DAF Contributions: Pairing a Roth conversion with a DAF contribution can be an effective strategy. A Roth conversion increases your taxable income by moving funds from a Traditional IRA to a Roth IRA. By making a DAF contribution in the same year, you create a larger charitable deduction, which can help offset the tax impact of the conversion.
- Using Non-Retirement Assets for Funding: Using assets outside of your retirement accounts is ideal for funding a DAF. Taking distributions from retirement accounts to contribute to a DAF may increase your taxable income unnecessarily and potentially trigger penalties or other tax consequences. By utilizing non-retirement assets, like appreciated securities or cash, you can maintain a more tax-efficient strategy while preserving retirement funds for future needs.
One of Many Charitable Giving Strategies: The Importance of Personalized Advice
While a Donor-Advised Fund (DAF) can be a highly effective tool for charitable giving, it’s just one of several strategies available. Depending on your financial situation, goals, and giving preferences, other options may be better suited to your needs. For instance, strategies like Qualified Charitable Distributions (QCDs) from an IRA, direct donations of appreciated assets, or even establishing a private foundation may offer distinct advantages.
Each charitable giving approach has unique benefits and considerations. A DAF offers flexibility in managing the timing of donations and immediate tax deductions, but it’s irrevocable and may create some illiquidity. Meanwhile, QCDs, for example, can be especially tax-efficient for those over 70½ with traditional IRAs, allowing you to fulfill required minimum distributions while supporting charity.
Getting individualized advice from a financial professional or tax advisor can ensure that your giving strategy is aligned with both your charitable intentions and financial goals. A professional can help you evaluate different strategies and maximize tax benefits, considering your specific income level, asset types, and long-term planning needs.
Disclaimer:
The information provided in this financial planning post is intended for general informational purposes only and should not be construed as personalized financial, investment, tax, or legal advice.
Financial planning is a complex and highly individualized process that takes into account your unique financial situation, goals, and risk tolerance. While this post aims to provide useful insights and guidance, it is not a substitute for professional advice tailored to your specific circumstances. We strongly recommend that you consult with a qualified financial advisor, tax professional, or legal expert before making any financial decisions or implementing any financial strategies. Any decisions made based on the information in this post are solely at your own risk.