Don’t let taxes drive charitable giving

The end of the year is a popular time for charitable giving, with the holiday season inspiring a philanthropic mood and investors having a better view of their annual balance sheets.

Investors have many ways to give with an eye toward their tax bill, but tax efficiency typically shouldn’t drive a conversation around gifting. Rather, advisers should first discuss what outcome clients are looking for from their charitable donations, which narrows the strategies used for charitable giving, and from there, advisers can tackle efficiency relative to a tax bill.

“Charitable strategies are best understood as proactive and intentional, not reacting at the end of the year to what the latest tax news of the day is,” said Thomas West, senior associate at Signature Estate & Investment Advisors.

Here are some often-used strategies advisers can employ with clients relative to philanthropic gifts.

DONOR-ADVISED FUNDS

Tapping a donor-advised fund as a way to accomplish charitable giving is becoming increasingly popular, mainly because awareness of them has grown among advisers, according to Tim Steffen, director of financial planning at Baird.

Donor-advised funds allow clients to make a sizable donation at one time but pay out the money to one charity or several different charities over a number of years. These vehicles are especially appropriate for clients committed to a long-term horizon for gifting but who haven’t made up their minds about which beneficiary will ultimately get the money, Mr. West said.

From a tax standpoint, donor-advised funds can prove useful for those with an unusual spike in income this year, due to a large bonus or business sale, for example, that bumps a client into a higher income tax bracket, Mr. Steffen noted. In that scenario, a tax deduction would be most useful to the client this year, and using a donor-advised fund would allow for front-loading many years’ worth of gifting into one tax return.

APPRECIATED SECURITIES

Using long-term appreciated assets in taxable accounts as a way to give to charity is another popular avenue for advisers.

“That’s the No. 1 spot where we end up giving to charities,” said Kevin Houser, managing partner at Houser and Plessl Wealth Management Group.

It’s an effective ap-proach for clients with assets that have rallied sharply, according to Mr. Houser, because they can get a double benefit of de-risking their portfolio and avoiding capital gains taxes on the asset sale.

“We see our clients who are regular givers and who have portfolios regularly look to see whether they can make gifts of appreciated securities at this time of year as opposed to cash gifts because it’s so much more tax efficient,” said Suzanne Shier, chief of wealth planning and tax strategy at Northern Trust. Clients receive a tax deduction on the fair market value of a security.

CHARITABLE GIFT ANNUITIES

Charitable gift annuities are appealing particularly to older clients, usually those over 75 years old, according to Mr. West.

This strategy involves donating a sum of money to a charity, which then agrees to provide a monthly or annual income payment from that money for the rest of the donor’s life. Charities that offer these annuities don’t actually put the money in an annuity, but pay the income stream from the charity’s general fund.

The older the donor, the higher the payout back to that donor. Tax deductions are calculated by the charities at the time a gift is made, based on the donor’s age.

Charitable gift annuities “are appealing to folks that want to give but are worried they’ll want to get money back in some way,” Mr. West said. They’re also more popular in low-interest-rate environments because other vehicles such as bonds and CDs aren’t providing very high yield, he said.

TRUSTS

A charitable remainder trust is similar to a charitable gift annuity — a donor makes a gift, typically a one-time payment, into the trust, which then offers an income stream to the donor or the donor’s specified beneficiaries.

When the donor dies, assets not paid from the income stream pass to a designated charity. The trust can pay out to individuals in a fixed dollar amount each year or as a percentage of assets in the trust. Rather than assets passing at death, donors also can specify a period for the payments, not to exceed 20 years.

Charitable lead trusts are the opposite of remainder trusts — they pay out a gift to charity every year, and upon death, or after a particular time period, the remaining assets go to a beneficiary.

Both types of trusts are most appropriate for high-net-worth individuals. Mr. Steffen estimates an investment of around $500,000 as a minimum for the strategy to make sense economically. High costs can be associated with set-up and maintenance of charitable lead trusts.

Advisers also point to using a traditional individual retirement account for charitable giving.

Clients with IRAs need to take required minimum distributions from their accounts each year starting at age 701/2, and those distributions are taxed as ordinary income.

Advisers expect Congress will pass legislation by year-end to reinstate a provision retroactively for 2015 that allows in-vestors to make up to a $100,000 gift to a qualified charity using RMDs without that amount being figured into taxable income.