Anyone contemplating retiring in the next few years already has a lot on their mind—wrapping up things at work and planning the next phase of life, getting financially confident they are ready to make the leap, building a retirement income plan, and navigating the healthcare transition that comes with leaving an employer.
All essential areas to address but the retirement transition period provides a tremendous opportunity for tax planning and reducing your tax liability over your lifetime as well. With that in mind, let’s take a look at three strategies most retirees we talk to don’t know about, but absolutely should.
Donor Advised Funds
With the implementation of the Tax Cuts and Jobs Act in 2018 and the increase to the standard deduction amount, fewer people benefit from itemizing their deductions. Meaning, for many, a loss of their tax benefit for charitable giving.
One way around this, to continue receiving the tax benefit of charity, is to front-load several years of charitable giving by utilizing a Donor Advised Fund (DAF). A DAF is a charitable fund in your name that allows you to take a tax deduction in the year the DAF is funded and distribute the money to charity over time.
An example might help. Let’s assume Mary Smith has historically contributed $5k to charity each year. In the past, this amount was deductible but is now replaced by the standard deduction. Mary can elect to place $25k in a DAF in her name and fund five years of charitable deductions. By lumping her charitable giving, she can take the $25k tax deduction in year one but spread out the charitable giving over five years (or at her discretion).
For more about this strategy, Cordant Advisor Scott Gerlach has a post on the topic here.
Charitable Remainder Trusts (CRTs)
Like DAFs, Charitable Remainder Trusts (CRTs) are a potential strategy to make a one-time charitable contribution and receive the tax benefit in year one and maintain the ability to distribute the funds down the road. However, unlike the DAF strategy, CRTs can be set-up to provide income to the donor (or their beneficiaries) over their lifetime.
A CRT works as follows:
- Individuals place assets (cash, publicly traded securities, real estate, some private company stock) in a trust;
- A tax deduction is taken in the year the CRT is setup;
- You, or your beneficiaries, receive an income stream from the assets;
- And lastly, based on a pre-defined timeline or the death of the last beneficiary, the remaining balance of the CRT is distributed to the charity of your choice.
This strategy might be right for a retiree with highly appreciated securities and a need for income today, but with charitable estate objectives.
For example, we’ll assume Gary Moore is set to retire in the next year with $1m in his company stock with very low-cost basis. Instead of selling the stock and generating capital gains, Gary, with the help of his advisor and CPA creates a CRT and places the company stock in the trust. Gary gets an income tax deduction in year one, is able to diversify by selling the stock in the trust without realizing capital gains, and can produce a stream of income (5% to 50% of the balance depending on actuarial tables).
Note, this isn’t a strategy that should be considered without proper planning. For starters, CRTs are irrevocable—meaning once the assets are placed into the trust, it can’t be unwound. Additionally, unless 10% of the initial value of the assets end up with the charity, the tax benefits could be lost. This means retroactively losing the income, gift, and estate tax deduction benefits. When considering this strategy for our clients, we partner with their CPAs and Estate Attorneys to determine whether a CRT is right for them.
For more on this strategy, Fidelity Charitable has a good overview here.
Our last tax strategy for retirees is the Roth conversion. This strategy capitalizes on the period between when one’s W2 income stops and before Required Minimum Distributions (RMDs) kick in, currently at age 70 1/2.
The idea is to convert as much income as possible out of a tax-deferred account at a low-income tax rate during this period and convert it into a tax-free Roth IRA. Most of the time, it makes sense for retirees to convert funds to fill the 10% or 15% income tax bracket versus paying at the 25% bracket down the road.
For more on this strategy, see our post here.
Hopefully, you find these three strategies helpful, and now that you know about them, take them seriously. They could save you thousands or hundreds of thousands of dollars over your retirement.
If you’re curious for more, check out two related podcasts Cordant Advisor Scott Malbasa has recorded here:
- Incorporating Philanthropy Into Your Financial Plan with Bill Hawke
- The Everyday Guide to Tax Planning for Retirement
And lastly, if you’d like to talk about any of these strategies in more detail, get in touch with our team of financial specialists here.
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