DAFS, QCDS, ROTHS AND 2019 TAX PLANNING-2020 IS COMING

Hope everyone had a great Halloween. Now, it’s time to finish your 2019 Tax Planning. You know the drill. You can’t extend December 31st– it’s the last day to get major tax planning resolved and implemented. This year we will focus on three key areas; Donor Advised Funds, Qualified Charitable Distributions and Roth accounts. And, then finish with some overall points to remember.

Donor Advised Funds (“DAFs”). For charitable gifts, this simple, tax-smart investment solution has become a real favorite, particularly starting in 2018. The concept of DAFs is that taxpayers can contribute to an investment account now and get a current deduction yet determine in the future where and when the money will go.

The Tax Cuts and Jobs Act of 2017 increased the standard deduction (up to $24,400 in 2019 for married couples). Couples with itemized deductions less than the standard deduction receive no tax benefit from their contributions. However, they could get a benefit by “bunching” their contributions using a DAF.   For example, if a couple made annual charitable contributions of $10,000 per year, they could contribute $40,000 to the DAF in 2019, e.g., and certainly, in that case, their itemized deductions would exceed the standard. The $40,000 would be used as their charity funding source over the next four years. In this manner, they would receive the full $40,000 tax deduction in 2019 for the contribution to the account, though they will not receive a deduction in the years after for the donations made from this account.

Now, what’s really great about a DAF is that if long-term appreciated securities are contributed to the DAF, you won’t have to pay capital gains taxes on them and the full fair market value (not cost) qualifies as an itemized deduction, up to 30% of your AGI. Why use after tax dollars for charity, when you can use appreciated securities?

Within the DAF, your fund grows tax-free. You or your wealth manager can manage the funds. The funds are not part of your estate. However, you advise your custodian, such as Schwab, the timing and amounts of the charitable donations. In general, your recommendations as donor will be accepted unless the payment is being made to fulfill an existing pledge or in a circumstance where you would receive benefit or value from the charity, such as a dinner, greens fees, etc.

Many taxpayers are using the DAF as part of their long-term charitable giving and estate planning strategy. They annually transfer long-term appreciated securities to a DAF, get a nice tax deduction, allow the funds to grow (unlike Foundations which have a 5% minimum distribution, there are no minimum distributions for DAFs) and then before or after their passing, the charities they support receive the benefits.

Qualified Charitable Distributions (“QCDs”). A QCD is a direct transfer of funds from your IRA to a qualified charity. These payments count towards satisfying your required minimum distribution (“RMD”) for the year. You must be 70 ½ years or older, you can give up to $100,000 (regardless of the RMD required) and the funds must come out of your IRA by December 31. You don’t get a tax deduction, but you make charitable contributions with pre-tax dollars. Each dollar in QCDs reduces the taxable portion of your RMD, up to your full RMD amount.

For taxpayers 70 ½ or older, their annual charitable contributions generally should be QCDs and if their gifting exceeds their RMDs, they can either do QCDs up to $100,000 annually or, instead of QCDs,fund a DAF with long-term appreciated securities and bunch the contributions to maximize the tax deduction.

Roth Accounts. A Roth IRA is a tax-advantaged, retirement savings account that allows you to withdraw your savings tax-free. Roth IRAs are funded with after-tax dollars. They grow tax-free and distributions of both principal and interest are tax-free. Roth IRAs do not have RMD requirements that traditional pre-tax IRAs have. They can be stretched by spouses and beneficiaries without tax. They are the best type of account that a beneficiary could receive upon your passing.

A taxpayer can convert an IRA to a Roth account anytime, regardless of age or income level- the IRS is happy to get your money. A Roth conversion is especially appealing if you expect to be in a higher marginal tax bracket in retirement. Conversions make sense when taxable income is low or negative. In addition, some couples interested in Roth conversions make DAFs in the same year to keep their taxes where they would have been without the conversion or the DAF.

2020 is coming. You still have almost two months to resolve your 2019 tax planning and get it implemented. Make sure you and your CPA review your situation before year-end to make sure you understand your likely tax status and review possible strategies that could help you. At DWM, we don’t prepare tax returns. However, we do prepare projections for our clients based on our experience and knowledge to help them identify key elements and potential strategies to reduce surprises and save taxes. Time is running out on 2019. Don’t forget to do your year-end tax planning. And, of course, contact us if you have any questions.

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Retirement Strategies You Shouldn’t Overlook: Back-Door Roths & QCDs

irarotheggsWithin the last several days, President Obama released his 2017 budget proposal to the public. Included in the proposal were many provisions that targeted retirement income. Between this proposal targeting retirement income and the Bipartisan Budget signed last year that eliminated Social Security claiming strategies, it sure seems retirement strategies are being picked on quite a bit lately. But let’s remember, the President’s proposal shouldn’t be seen as anything more than a “wish-list”. While the “wish-list” provides a good indication of where the administration may be heading, it could take years before any of the provisions gain traction. In the meantime, it’s important to take advantage of the retirement strategies available to us.

One strategy that the President’s proposal would eliminate but is still available this year is known as a “backdoor” Roth. A Roth IRA is funded with after-tax dollars which allows the funds to grow tax-free. In addition, Roth IRAs do not require a minimum distribution to be taken. The limitation with Roth IRAs is that higher earners are not allowed to contribute to these accounts. In the spirit of the law, this would only give these individuals access to a traditional IRA. Traditional IRAs are funded with pre-tax dollars which are then taxed upon withdrawal. These accounts also require a person to take a minimum distribution starting at age 70 ½. By using a “backdoor” approach, these higher earners can have the benefit of contributing money to a Roth IRA. The sequence of action would be for the person to contribute to a nondeductible IRA, then convert to a Roth immediately afterwards. If the taxpayer does not have any pre-tax funds in their IRA, the conversion can be made without tax.

Late in 2015, Congress made permanent a few tax provisions that were set to expire at year-end. One in particular allows individuals to make charitable donations directly from their traditional IRA without treating the distribution as taxable income. As mentioned above, distributions from a traditional IRA are generally taxable and are required when a person reaches age 70 1/2. This transaction, known as a Qualified Charitable Distribution (QCD), will count towards the required minimum distribution but will not be treated as taxable income. To be considered a QCD, the individual must be age 70 ½ or older, the distribution must be paid to a public charity, the full payment must qualify as a charitable contribution and the distributions must be a direct transfer from the IRA trustee to the charity.

Being that the QCD is excluded from taxable income, the charitable donation itself cannot be deducted on an individual’s tax return. At first glance, this may seem to provide no real tax benefit. Why not just include the distribution as income and take the deduction? For many people, this may be the right strategy. For those individuals that are subject to itemized deduction phaseouts and the 3.8% Medicare tax on investment income, a QCD can help minimize or avoid these consequences. In addition, excluding IRA distributions from income will lower adjusted gross income (AGI) and may make it easier to deduct medical expenses and miscellaneous expenses subject to 2% of AGI, reduce the taxability of social security benefits and minimize the Medicare Part B insurance premiums.

It’s typically best practice to make your Roth or Traditional IRA contributions early in the year, so they can grow tax-free or tax deferred all year. Most of you will be meeting with your CPA or financial advisor within the next several weeks. This will be a good time to discuss these two strategies and see if they will work for you. Here at DWM, we are always happy and available to have these discussions with our clients, during tax season or not. Please let us know how we can help.