Making gifts to charitable organizations is an important part of many people's financial plans. For some, this means giving during their lifetimes while others choose to leave money to charity as part of their estate plan. Some, of course, do both. When considering making charitable gifts, it's important to balance your wish to support the causes and organizations that you care about with your income needs, the needs of your beneficiaries, and the tax benefits of making charitable gifts and bequests.
Charitable gifts can be made in a variety of ways, including directly to a charity, to a donor advised fund or foundation, or through a trust. Before you choose a way to give, it's important to understand the tax implications of your decisions. Making gifts to charity during your lifetime may help to reduce federal and state income taxes while making a bequest to charity as part of your estate plan may help to reduce federal and state estate taxes.
Gifts made to charities, specifically, are exempt from gift tax.
Generally speaking, lifetime gifts to qualified charitable organizations can result in an income tax deduction for you. But before you make a sizable gift, be sure to seek tax advice. You're eligible for itemized deductions for charitable contributions up to a certain percentage of your adjusted gross income for cash contributions. Another limit applies for contributions of appreciated securities or property in any one year. These limits may be further reduced depending on whether you are making gifts directly to a public charity, a private foundation, or using other charitable strategies (some of which we discuss below). In situations where you are unable to use the full deduction in one year, you may be able to carry forward amounts that exceed the limit and deduct them over the next five years.
Highly appreciated securities may be good candidates to give to charity during your lifetime; in addition to the income tax deduction, you bypass the capital gains tax that would be owed if you cashed them in yourself.
Specialized options for charitable giving
While many people choose to simply make gifts directly to charitable organizations, there are other options to accomplish your charitable goals. One such option for both lifetime gifts and gifts made at your death is using a donor-advised fund ("DAF"). A DAF is a charitable fund maintained by a public charity (a "sponsored organization") that is exclusively dedicated to charitable giving. When you contribute to a donor advised fund during your lifetime, you are eligible for an immediate income tax deduction. When assets pass to a DAF at your death, there may be estate or inheritance tax benefits. Once your DAF has been funded, you can then recommend grants to any IRS-qualified public charity
If you have the means and desire to play an active role in philanthropy, you might also consider establishing a private foundation. A private foundation is a charitable organization typically established by an individual or family with a substantial initial gift. A board of directors or trustees oversees the private foundation and is responsible for receiving charitable contributions, managing and investing charitable assets, and making grants to other charitable organizations. In addition, foundations may also be directly involved in operating a charitable project or enterprise such as running a museum, providing scholarships, and making hardship grants to individuals. Along with this flexibility, however, is a significant amount of administration.
Trusts for giving to charity
Charitable lead trusts are irrevocable trusts that generate a potential income stream for charitable beneficiaries, with the remaining assets eventually going to non-charitable beneficiaries, such as your children or grandchildren.
Charitable remainder trusts are irrevocable trusts that generate a potential income stream for you or another beneficiary, with the remaining assets eventually going to charitable beneficiaries.
A charitable lead trust ("CLT") lets you provide a payout to a charitable cause during your lifetime (or a term of years) and preserve assets for other beneficiaries, such as children or grandchildren. The value of the remainder gifted to your descendants will be a taxable gift if the trust is funded during your lifetime, or subject to estate tax, if the trust is funded at your death. CLTs are not tax-exempt, and the tax treatment of the trust can vary, depending on how you set it up.
A charitable remainder trust ("CRT"), on the other hand, generates an income stream for you during the term of the trust (for instance, your lifetime or a specific number of years). A CRT may also name someone other than you as the recipient of the income, however, this has gift / estate tax ramifications. At the end of the trust term, any remaining assets pass to the charitable beneficiaries that you named in the trust. A CRT is a tax-exempt entity so investment income (such as capital gains, dividends, and interest) generated by the trust are exempt from tax, but distributions to the income beneficiaries may be taxable and are subject to special tax rules. CRTs are often funded by clients who have substantially appreciated assets (such as real estate or stocks) that they wish to sell, since this defers capital gains tax on the sale of the assets and provides them with an income stream.
Retirement assets, such as IRAs and 401(k)s, may be good candidates for charitable bequests because they can be among the highest taxed assets in any estate. Leaving your retirement assets to a charity has two distinct advantages:
- Increasing the impact of your bequest: The charity would not have to pay income taxes on the assets it receives from your retirement account.
- Decreasing the estate tax burden for your family: Your assets would pass to the charitable organization, so your estate would be eligible for a federal estate tax charitable deduction on the account's value.
As always, make sure your beneficiary designations are up to date; when designations are missing or incorrect, your assets may not be distributed as you intend or your charitable beneficiaries may have to wait to take ownership and your estate may incur costs due to probate.
The rules for 401(k)s and other qualified retirement plans are similar to those for IRAs. However, If you are married and you want to designate beneficiaries other than your spouse, you may need written consent from your spouse. Other features may also vary from plan to plan so it is important to contact the plan's administrator for specific rules governing yours.
For more information about making charitable deductions, choosing where and what to donate, and the various charitable gifting strategies discussed above see Making Charitable Donations on Fidelity.com.