The Art of Giving
Most of us spend more time building up our net worth than we do in figuring out how to give it away for maximum benefit. Nobody argues with the fact that you can't take it with you, but a lot of people try to delay letting go of it right up to their date of departure. Consequently, charity begins not at home, but at the reading of the will. – Peter Lynch, Bestowing Gifts, May 1993
Founding Father Benjamin Franklin was the first to say, “nothing is certain except death and taxes.” His wisdom holds true today, and while we can’t control the former, we certainly can plan for the latter. Sadly, only one in three American adults have wills or living trusts. If one dies intestate (without a will), the laws of the decedent’s state of domicile will determine how assets are distributed.
In all cases, the first step is to draft a will. Once the will is in place, the assets must go through a legal process called “probate.” A pre-existing will can make probate less painful, but it is generally accompanied by distribution delays, additional costs (attorneys and court fees), and public scrutiny (probate records are public).
Traditional individual retirement accounts (IRAs), Roth IRAs, employer-sponsored plans, and life insurance avoid probate because a beneficiary must be on record for the account owner to open the account. Non-retirement investment accounts, however, are subject to the probate process unless they are part of a revocable living trust or have an account type that specifically allows for a designated beneficiary – such as an individual “Transfer on Death” account or a “Joint Tenants by Entirety” account. To further complicate matters, tax laws are always subject to change, so it’s clear estate planning is paramount. We recommend planning early and revisiting regularly to ensure your funds will be distributed how you wish within the boundaries of current tax laws. Fortunately, what used to be one of the biggest concerns for estates – the inheritance tax – has become far less cruel.
In 1997, only the first $600,000 of an estate (or $1.2 million for a married couple) was exempt from inheritance taxes. Above this exemption amount, Uncle Sam carried a top federal tax of 55%. Now, the top federal tax bracket is 40% and the estate exemption amount is a whopping $12.92 million ($25.84 million for a married couple). Expectedly, breaching the estate tax exemption amount is not a concern for most retirees nowadays; it’s worth noting that this limit is scheduled to “sunset” at the end of 2025 and fall to $6.2 million ($12.4 million for a married couple). Still, estate planning is vital for estates of any size because it assures the assets will be distributed as desired without unexpected costs or delays, and potentially avoids probate.
Required minimum distributions (RMDs) are annual distributions mandated by the Internal Revenue Service for owners of traditional IRAs and traditional 401(k)s who are at least 73 years old. The RMD starts as a small percentage of the retirement account’s market value and increases with age, and is taxed at the owner’s marginal tax rate. Even if the account owner does not need the RMD, it is still required to be distributed. If one fails to take their RMD in time, Congress imposes a 25% penalty on the amount not taken (it was a 50% penalty prior to the January 1, 2023 enactment of the “SECURE Act 2.0”). A common strategy to satisfy the RMD for those who do not need the funds is to simply transfer it to a personal after-tax investment account. That way, assets can remain invested and continue to grow. Of course, the Government still gets its cut.
Qualified charitable donations (QCDs). To avoid Federal income tax on an IRA distribution, consider QCDs. Beginning at age 70 ½, a traditional IRA owner can distribute up to $100,000 annually from their traditional IRA to a qualified charity free of taxes. For those subject to a Required Minimum Distribution (RMD), this can help satisfy the RMD mandate.
Highly appreciated stock. For clients with charitable intent who own highly appreciated stock, the advantages of donating these shares cannot be overstated. When shares of individual stocks are donated from any type of after-tax account, the fair market value of the stock donation is fully deductible. If an individual in the 37% tax bracket donated $10,000 of cash to a charity, they can deduct $3,700 from their taxes, making the donation cost effectively $6,300. If that same individual had $10,000 worth of stock XYZ that they initially purchased for $1,000, they could donate the shares in-kind, write-off the $3,700 as with the first case, and also forgo the associated maximum capital gains tax liability of $2,142 ($9,000 of capital gains x 23.8% long-term capital gains tax rate and net interest income surtax). In this example, the XYZ stock donation had an effective cost of $4,158 instead of $6,300 if the donation were made with cash.
Donating highly appreciated stock isn’t suitable for everyone: In most cases, the cost basis for shares under consideration will “step-up” when the account owner dies. If the account owner is older, it likely makes sense to hold those shares until the assets are bequeathed and “stepped up” rather than donating the shares to charity.
Donor-advised funds (DAFs). Conducting QCDs or donating stock has never been easier! What used to be an onerous and expensive task of establishing a foundation, a DAF is a charitable account that can accept donations in the most favorable form for the donor, whether cash or assets in-kind and from either retirement or non-retirement accounts. The contribution is irrevocable and thus tax deductible in the year it occurs. At the donor’s discretion, they can direct the DAF to distribute funds to a qualified charitable organization; timing and amount are subject to the donor's preference.
For example, PASI’s own senior analyst and nutrition maven Nathan Polackwich can mail a $5,000 check to a foundation committed to ending the production of vegetable oils (of which he is particularly passionate). If that foundation doesn’t yet exist but he wants the tax write-off today, he can donate $5,000 of cash or stocks to “Nathan’s Donor-Advised Fund.” In both cases, he gets the immediate tax deduction, but with Nathan’s DAF, he can then let the $5,000 grow unencumbered by tax consequence, outside of his estate, for what could be decades before finding a suitable and qualified non-profit for the proceeds.
Annual gifting. Of course, charity doesn’t have to start in retirement, and it doesn’t need to be to a not-for-profit organization. In 2023, adults can gift $17,000 annually to any individual without Federal gift tax consequences, and couples can gift $34,000; the limit is adjusted annually. Gifting to children and grandchildren is an incredibly useful strategy to move assets out of your estate without owing taxes to the Government. These types of annual gifts can be contributed directly into after-tax Custody accounts, can be held for the benefit of minors (UTMA accounts or trusts … see below), or can be used to fund a 529 plan.
529 plans. A 529 plan is a tax-advantaged educational account. Funds can grow and be distributed tax-free if used for qualified expenses, or transferred to a qualifying family member if not depleted by the original beneficiary. Each year, individuals and couples can contribute up to the annual gift amount without incurring gift tax liability. They could also “superfund” a 529 plan by contributing up to five years’ worth of contributions in one lump sum: $85,000 for individuals and $170,000 for couples (in 2023). Of note, 529 plans are typically run by states. You can choose any plan you want, but if your state offers a tax deduction, it's likely best to contribute to the state plan. It's always worth comparing all states and all options regardless.
Uniform Transfer to Minors Act (UTMA) account. Gifts do not have to be confined to education expenses. Consider an after-tax account for minors like a UTMA account. Gifts to UTMA accounts are irrevocable, and unlike 529 plans, funds can be withdrawn at any time without restriction if the money is used to benefit the minor. A couple can donate $34,000 every year to their children and spouses, and their children’s children, and so on, all without tax consequence. Unlike 529 plans, these accounts are subject to income and capital gains taxes. UTMA accounts offer incredible flexibility for wealth transfer purposes, but they do impact college financial aid considerations to a much greater degree than 529 plan assets. Also keep in mind that UTMA accounts officially transfer to the minor at the age of majority, either age 18 or 21, as determined by the state. If longer term control of assets gifted to a minor is a concern, consider creation of a trust for the minor which will allow comparable gifting but adds more options regarding control.
Whether you are interested in qualified charitable distributions, donating low-cost basis stock, establishing your own donor-advised fund, or setting your grandchildren up for financial success, we are here to help. PASI is fully equipped to manage DAFs and UTMA accounts with the same level of diligence and care as your current accounts. Please reach out to any Portfolio Manager if you’re interested in learning more!
We recommend discussing all tax implications with your accountant and estate planning implications with your attorney. We are always happy to work together with other professionals to ensure we are meeting your financial goals holistically.
