Financial Planning

Using Your IRA to Have an Enduring Impact

June 23, 2023 by Red Tortoise, LLC

If you’re looking for a way to make a lasting difference with your IRA, consider using qualified charitable distributions (QCDs). QCDs are direct donations from your IRA to charities of your choice. Doing this reduces your taxable income, supports a cause you care about, and leaves a legacy that will last beyond your lifetime. In this post, we explain how QCDs work, the benefits and requirements, and unique ways they can support your philanthropic goals.

How They Work

A qualified charitable distribution (QCD) is a direct transfer of funds from your individual retirement account (IRA) to a qualified charity. A QCD can lower your taxable income while satisfying your required minimum distribution (RMD) for the year. To be eligible for a QCD, you must be at least 70½ years old and follow the IRS rules for this type of donation. The maximum annual amount is $100,000 indexed for inflation.

Benefits

In the tax planning arena, there are very few savings vehicles that allow you an income tax deduction upon your contribution, tax free income as it accumulates, and zero income taxes when you take it out. This can all be accomplished with all, or a portion, of a traditional IRA, if the distributions occur after age 70 ½ as QCDs. This makes the most sense for those who have the interest, and the capacity, to direct a portion of their wealth to charity. Consider the following example:

John and Sally Smith are seventy-one years old and have significant assets in IRAs. Their RMD’s exceed $10,000 per year and their marginal tax rate is 30%. John and Sally would like to donate $10,000 to charity each year for the next twenty years. They do not itemize their deductions.

Using QCDs would enable them to donate $200,000 to their favored charities. In contrast, if they were to take the $10,000 directly, pay $3,000 in tax, then the charities would enjoy $140,000 while Uncle Sam pockets the other $60,000.

As the example illustrates, careful planning of the source and timing of your charitable donations can have a big impact.

Requirements

Not all charities are eligible to receive QCDs. Only 501(c)(3) organizations may receive QCDs. This generally includes public charities such as universities, religious organizations and relief organizations like the Red Cross. Some types of 501(c)(3) organizations are excluded. You should particularly note that donor-advised funds (DAFs), and private foundations are not eligible for QCD treatment.

Alternatives to donor-advised funds

There are however three types of charitable funds that resemble donor advised funds and qualify for QCD treatment. These funds are available through community foundations and below is a brief description of each:

Scholarship funds: These provide financial assistance to students pursuing higher education. The donor can specify the eligibility criteria for the scholarship recipients, such as academic merit, financial need, field of study, or geographic area.

Designated funds: These support one or more specific charities of the donor’s choice. The donor names the beneficiary charities at the time of establishing the fund.

Field-of-interest funds: These support a broad area of interest, such as education, health, arts, or environment. The donor does not name specific charities, but rather identifies the specific issues or populations they want to impact.

With each type of fund there are varying degrees of ongoing donor involvement that may be permitted which will vary based on the policies and practices of the sponsoring community foundation.

Summary

Whether you prefer to designate QCD’s to support a charitable cause immediately, or gradually using Scholarship Funds, Designated Funds or Field-of-Interest Funds, they can help you achieve your philanthropic goals in a tax efficient manner. They should be considered along with the various other charitable giving strategies available.

Other Considerations

The most tax efficient ways to satisfy your charitable giving goals will vary based on your unique circumstances. Relevant factors include whether you itemize deductions or take the standard deduction, your current and expected future tax rates, and the availability of low basis, highly appreciated assets.

If you are unsure whether a charity is eligible for QCDs, consult with your tax advisor or the charity itself before making a donation. Keep a record of your QCDs and obtain a written acknowledgment from the charity for each donation. This will help you report your QCDs correctly on your tax return.

QCD’s and donor advised funds (DAFs) can complement each other. While DAFs are not a qualifying charity eligible for QCD treatment, distributions from a DAF can be made to Scholarship Funds, Designated Funds or Field-of-Interest Funds. If you already have a DAF, you can make distributions from both the DAF and the IRA to these three types of funds.

The administrative fees charged by community foundations for an endowment type fund can be as high as 2% per year so you should comparison shop.

Other Sources of Information

For IRS guidelines to QCD’s: https://www.irs.gov/newsroom/seniors-can-reduce-their-tax-burden-by-donating-to-charity-through-their-ira

The largest community foundation in the United States as measured by assets is Silicon Valley Community Foundation. They provide a representative list of giving options that may be available through your local community foundation: https://www.siliconvalleycf.org/donors/charitable-giving-options

For ways of giving via the Community Foundation of Greater Atlanta: https://cfgreateratlanta.org/philanthropists/getting-started/

Ukraine – Ways You Can Help

March 14, 2022 by Red Tortoise, LLC

“It is more difficult to give money away intelligently than to earn it in the first place.”
-Andrew Carnegie

As the tragic war in Ukraine unfolds, Red Tortoise clients looking to aid the millions of victims of the war have asked for our input in maximizing the impact of their donations. To help, we have assembled a list of resources to locate organizations that are serving their needs.

Charity Navigator is a nonprofit organization that provides donors with free access to data, tools, and resources to guide philanthropic decision-making. They evaluate charities on how efficiently they steward donations. They assemble a list of highly rated organizations involved in the Ukraine humanitarian relief, recovery, and peace-building efforts. Their list can be found here: Charity Navigator

Vanguard Charitable is a large sponsor of donor-advised funds. In conjunction with Charity Navigator they prepared a list of highly rated organizations responding to the situation in Ukraine. Their list can be found here: Vanguard Charitable

CAF America is an organization that enables cross-border giving by Americans. They help facilitate gifts to foreign charities in a way that qualifies for a Federal charitable income tax deduction. They charge fees to facilitate such gifts. For those looking to be more adventurous with their giving their list can be found here: CAF America

You will notice that many of the charities are very large and established organizations. Donating to such charities helps protect you from inadvertently donating to a fraudulent scheme. Donating to a large organization also warrants some caution if you wish your donation to support a specific cause. These organizations often provide relief to many causes and geographies, so if you want your donation to support a particular cause you need to specify it at the time you make the donation.

Our list is not a complete list of organizations assisting in this effort. We encourage you to research any organization you give money to ensure your contribution is used for good ends.

We encourage you to be tax smart when making your charitable gifts. By doing so, you can maximize the impact of your giving. See our post on the topic The Exponential Benefits of Charitable Giving. Please be aware that gifts made directly to foreign charities are generally not tax deductible. Should you have any questions about the best way to proceed, please contact us.

The Exponential Benefits of Charitable Giving

October 21, 2021 by Red Tortoise, LLC

We have all heard the phrase “it is better to give than to receive.” Recent scientific research supports the notion that giving one’s time, talents and treasures is a powerful pathway to finding fulfillment in our lives. One of my favorite quotes on the topic is:

“If you want happiness for an hour, take a nap. If you want happiness for a day, go fishing. If you want happiness for a year, inherit a fortune. If you want happiness for a lifetime, help somebody.”
~Chinese proverb

Here is something you may not know. There is a lesser-known benefit that can be obtained from charitable giving. In the vernacular of the behavioral economist and Nobel Laureate Richard Thaler, it is known as transaction utility. More simply stated, it is the happiness we get from the value of a good deal.

To experience the joy of a good deal a few things are preferred. First, it is helpful but not necessary that you actually get a good deal. Second, you must consciously realize (or believe) that you are getting a good deal. What follows are some of the rules of the road for obtaining a good deal in your charitable giving by maximizing the tax benefit you receive when making them.

Establishing your good deal…

By lumping charitable gifts into one year, you can increase the tax benefit of your charitable giving by more than 30%. By changing the property given to charity from cash to low tax basis stock or stock funds, you can increase the tax benefit of your charitable giving by another 20% or more. In total, by changing the timing of charitable gifts and the property used to make them, you can get Uncle Sam to share in more than 50% of the cost of your charitable giving. How is that for a deal?

To get the best deal you should maximize the tax benefit of your charitable deductions and avoid capital gains taxes that you would otherwise incur. The techniques used to maximize these tax benefits are relatively straightforward.

Itemized Deductions vs. Standard Deduction

Let’s assume that you are married and file a joint tax return with your spouse. In 2021, you are entitled to a standard deduction of $25,100. You can take the standard deduction or if greater, you can itemize your deductions. The most common itemized deductions are state income and property taxes (currently capped at $10,000), mortgage interest, and charitable deductions. If the sum of each of your deductions exceeds $25,100 then you are better off itemizing. If the sum of all of your itemized deductions is less than the standard deduction then you are better off taking the standard deduction. You enjoy no income tax benefit from charitable gifts made in a year when your standard deduction exceeds your itemized deductions. By intentionally lumping charitable gifts into a single year, you may be able to increase your itemized deductions so that they exceed the standard deduction in that year and as a result increase your deductions over time.

For those who file as a single person the standard deduction in 2021 is $12,550.

The following example illustrates the potential tax benefits obtained by lumping charitable gifts.

David and Victoria Jones have the following annual deductible expenses:

· State income and real estate taxes = $10,000

· Mortgage interest = $10,000

· Charitable Gifts = $5,000

Using the typical direct annual gift approach, the Jones’ total annual itemized deductions would be $25,000. Because their total itemized deductions of $25,000 do not exceed the standard deduction for a married couple ($25,100) they would take the standard deduction every year. Over a four-year period, the Jones’ would deduct a total of $100,400 using the direct annual gift approach. Alternatively, if the Jones’ make $20,000 of gifts to charity in one of the four years and no gifts in the other three years, their total allowable deductions over the four-year period would be $115,300. The annual deductions the Jones’ would enjoy over the four year period is illustrated in the table below.

Table 2: Summary of annual deductions

Let’s assume that David and Victoria have a combined Federal and state tax rate of 38%. Based on that tax rate, the increased deduction would result in tax savings equal to approximately 28% of their gifts to charity merely by changing the timing of the gifts!

If the Jones prefer that their charities receive equal amounts over the years, they could use a donor advised fund (DAF). A DAF would allow them to receive the deduction for the lump sum in one year and direct their donations over the four years.

Donating Low Basis Stock

The second technique used to get the best deal is to donate low basis stock to avoid taxes on capital gains. This can be a benefit even if you don’t itemize. Let’s say you have $1,000 in a stock (or a mutual fund) for which you paid $400 implying you have an unrealized gain of $600. If you donate the stock, you avoid taxes on the gain and get a charitable deduction of $1,000. If you like the stock and want to continue owning it, just use the cash you would have used to make the donation to replace the donated stock. Pro tip: a single position in a stock or fund may be made up of several “tax lots” if you purchased the stock via multiple transactions including dividend reinvestment. These tax lots have different acquisition prices. You may donate shares from the lot with the lowest price (largest gain) to avoid the most capital gains tax.

Special rules for those over age 70 1/2.

Once you are over age 70 and one half, there is another opportunity for Uncle Sam to offer a lending hand. You can designate all or a portion of required IRA distributions to charity. In the tax code this is referred to as a qualified charitable distribution (QCD). This opportunity is particularly beneficial if you do not itemize your deductions because the amount of the IRA distribution designated to charity is not included in income regardless of whether you itemize your deductions.

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If these tax strategies sound appealing, but you are not sure how they apply to you, consider the table below. It provides rules of thumb applicable to each of these strategies based on your age and whether you itemize your deductions or take the standard deduction.

Table 1: Gifting alternatives rules of thumb

While both QCD and donating low basis stocks offer charitable deductions which may lower taxes, donating low basis stock additionally helps to avoid future capital gains taxes.

Be aware that while the above rules of thumb have broad application, there are a variety of other tax rules related to charitable giving that are beyond the scope of this article. Our goal is to raise awareness of some of the common techniques available to enhance the tax benefits of your charitable giving. As with any tax matters, consult with your C.P.A. to determine how the rules apply to your specific circumstances.

We hope this information enhances the joy you experience by helping others.

The Future Ain’t What It Used to Be

June 28, 2021 by Red Tortoise, LLC

An explanation of low forecasted returns

The financial news media has devoted considerable attention to the historically low level of interest rates and the implications for future investment returns. One such recent article was titled ‘Worst-case scenario warning for retirees and the 4% rule’. Expectations for future investment returns are critical in making decisions about the future beyond the obvious one of deciding how to invest. Decisions about retirement, home financing, and gifting to younger generations family members are often shaped by expectations for future investment returns. Our ten-year return forecasts (shown below) for U.S. bonds and stocks may surprise and disappoint some clients. Here we explain why we expect future investment returns to be lower than the past.

We focus this analysis on the core of our clients’ portfolios: U.S. bonds and stocks. Specifically, we use U.S. Treasury bonds and the S&P 500 index. Treasury bonds, given their lack of credit risk and liquidity, are a building block on which other asset prices are based. The S&P captures much of the U.S. stock market. Both series have long histories helpful for study.

The essence of this analysis is that expected future bond returns are low when the starting interest rate is low as it is today, and expected future stock returns are low when the starting price is high relative to earnings as they are today. These are similar stories. Bond investors aren’t getting much interest for their investment and stock investors aren’t getting many earnings for their investment both of which diminish expected returns.

Bonds

Figures 1 and 2 illustrate data from Aswath Damodaran of New York University. The columns in the first figure represent the initial rate on 10 Year Treasuries at the start of a year and the line represents the return to an investor who held 10 Year Treasuries for ten years. Figure 2 visualizes the correlation of this beginning interest rate to the subsequent actual 10 year return. Both figures show that when initial rates are low investors tend to earn low returns on Treasuries in future years.

Stocks

The cyclically adjusted price-to-earnings ratio (CAPE) was popularized by Nobel Laureate and Yale University professor Robert Shiller. It is the price of the S&P 500 stock index divided by the average of the previous ten years of inflation-adjusted earnings. The price-to-earnings ratio measures the number of dollars investors are willing to pay for one dollar of earnings. High ratios are generally considered expensive while low ratios can broadly be considered a bargain. Averaging ten years of earnings smooths the short-term volatility. We will show here that the CAPE helps predict future stock market returns as represented by the S&P 500 index. When the CAPE has been high, investors have been willing to pay more for earnings and future returns have tended to be less than when the CAPE is low.

The following charts say similar things in different ways. We present these because readers will have different preferences. We start simply by aligning the return of the S&P 500 (source: DFA) over the next ten years with the CAPE. We have used total returns (i.e., dividends and appreciation) for the S&P from 1926 through April 2021. This makes the ending date for the chart Apr 2011. It is clear in Figure 3 that high values of CAPE have generally been associated with low future returns and low values of CAPE have been associated with high future returns.

Next, we begin to quantify the relationship between the CAPE and future returns. Figure 4 shows the average future return of the stock market based on ranges of the CAPE. The ranges of the CAPE ratio in the plot were chosen so that close to an equal number of observations would fall into a group. Given that the current CAPE of 37 falls in the >=25 bin, we might expect something like a 4.2% return.

Finally, for the statistician, we provide, in Figure 5, a scatterplot and a regression line with confidence intervals. Each circle represents the CAPE for a particular month and the return of the stock market over the following 10 years. The circles are color coded to represent approximately a 20 year period. The red line is the best-fit regression line through all the data. The gray lines are the upper and lower confidence intervals. The vertical dashed line is the recent CAPE value. This graphic adds color both literally and figuratively. The more recent data (cyan) suggest that the relationship between future market returns and CAPE are different (higher) than in other periods. One can speculate about differing monetary policies (gold standard, Volcker) as potential causes. Regardless, higher CAPEs have historically been associated with lower future returns. Using all the data, the regression line indicates that each change of 1 in the CAPE reduces the future 10 year annual return by a bit more than one-half of one percent.

Figure 5 shows the 10 year estimated return given the current CAPE of 37 would be -0.4%. The 90% confidence interval is -6.6% to 5.9%.

Figure 6 is identical to the previous plot except it only uses the data beginning 1986. This produces a more optimistic forecast. One theory for the changed relationship is that better policies from the Fed beginning with Volcker have reduced macroeconomic uncertainty which leads to higher valuations in markets. Naturally, there is nothing to say that the theory is wrong or that policy will not change for the worse in the future.

With this model the 10 year estimated return given the current CAPE of 37 would be 1.3%. The 90% confidence interval is -2% to 4.5%.

Summary

History and theory indicate low future returns in the U.S. Given this expectation, here is our counsel:

The future may surprise us with better than expected returns. Forecast error leads us to diversify so we believe in keeping some exposure to the U.S.
Five companies (Facebook, Apple, Alphabet, Amazon, and Microsoft) comprise nearly 24% of the weight of the S&P 500 index (source: Vanguard Q2 2021 Chartbook). The performance of U.S. stocks as measured by a different index may perform better. For example, it may be that value stocks outperform the capitalization-weighted S&P 500 index. For this reason, we consider allocations to U.S. stocks that are not as heavily weighted to higher priced names.
Invest beyond the U.S. because yields are more attractive.
Remember that our forecasts span a 10 year horizon and returns in the meantime will differ markedly from this expected average.

Disclosures

The analysis in this report has been prepared by Red Tortoise LLC utilizing data from third parties. Reasonable care has been taken to assure the accuracy of the data contained herein and comments are objectively stated and are based on facts gathered in good faith; however, Red Tortoise cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Red Tortoise disclaims responsibility, financial or otherwise, for the accuracy or completeness of this report. Opinions expressed in these reports may change without prior notice and Red Tortoise is under no obligation to update the information to reflect changes after the publication date.

This report is being made available for educational purposes only and should not be used for any other purpose. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any investment advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

Past performance is no guarantee of future results. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Income Tax Considerations for Year End

November 22, 2020 by Red Tortoise, LLC

Tax planning is largely shaped by a comparison of your current tax situation to your future expected tax situation and timing your income and deductions to minimize your tax liability. In an election year, an additional variable takes heightened importance; the prospect of a change in the tax law. At the time of this writing, the makeup of the U.S. Senate and hence future tax laws are uncertain. For purposes of the ideas expressed herein, we have assumed that the current tax law will remain in place for the foreseeable future.

Manage Tax Brackets

One of the most important aspects of minimizing income taxes is understanding and, to the extent possible, managing your marginal tax rate. Below is the 2020 tax rate schedule for a single person and a married couple. Let’s assume that a married couple, Harry and Sally, have had a challenging year financially in 2020 and their taxable income is expected to be $150,000 compared to the $350,000 that it has been in the past and is expected to be in 2021 and beyond. This level of taxable income puts Harry and Sally in the 22% tax bracket in 2020 and the 32% tax bracket in 2021. In such a circumstance Harry and Sally will generally want to defer tax deductions to 2021 when they will be more beneficial. A $10,000 deduction in 2021 will be worth $1,000 more in 2021 than in 2020. Conversely, they would prefer to recognize additional income in 2020 than in 2021. The opposite would be true if Harry and Sally’s expected income in 2020 and 2021 were reversed.

Let’s examine some of the ways that Harry and Sally can shift their income or deductions from one year to another to manage their tax bracket as their circumstances change. They can:

 Change their elective deferrals to employer retirement plans and IRAs. The amounts of the contributions can be adjusted, and they can choose between pre-tax and after tax (Roth) contributions.
 Delay or accelerate their charitable contributions.
 Delay or accelerate the payment of state estimated income tax payments and property taxes.
 If self-employed, accelerate business income or delay business deductions.
 Take distributions from retirement plans that are not otherwise required.
 Convert all or a portion of a traditional IRA to a Roth IRA.
 Accelerate or defer capital gains and losses from the sale of financial assets.

Another reason to proactively shift income and deductions is to take advantage of the many tax breaks that are limited based on your income. Here is a list of some of the most common:

 American Opportunity Tax Credit – up to $2,500 Federal tax credit per child for those who have paid college education expenses and with income below $180,000.
 The COVID stimulus check – up to $2,400 Federal tax credit if your income is below $198,000.
 Child Tax Credit – up to $500 Federal tax credit per child if your income is below $400,000.
 Roth IRA contributions – up to $7,000 deduction per person if your income is below $206,000.

The above list is not all inclusive and is based on the income limits for a married couple. The amounts differ for those not married and filing a joint return.

Maximize Charitable Deductions

The 2017 Tax Cuts and Jobs Act (TCJA) expanded the standard deduction and capped the deduction for state taxes to $10,000. As a result of these changes many people that had previously itemized their deductions are now claiming the standard deduction. As a reminder, the standard deduction is the amount that you may deduct from your income regardless of the eligible itemized deductions you have actually paid.

These new rules have caused many to lose the tax benefit of their charitable contributions. For those impacted, the loss of the charitable deduction can be limited by bunching charitable deductions into a single year. Consider the following example:

Harry and Sally Jones paid $75,000 of state income and property taxes. This deduction is limited to $10,000. They have no mortgage and they gift $30,000 annually to charity. Using the typical direct annual gift approach, the Jones’ would elect to itemize their deductions because their itemized deductions of $40,000 exceed the $24,400 standard deduction for a married couple. Over a four-year period, the Jones’ would have deducted a total of $160,000 using the direct annual gift approach. Alternatively, if the Jones’ pay the next four years of their charitable giving in year one their total allowable deductions over the four-year period would be $203,200. This is a $43,200 increase in deductions merely by changing the timing of the payment!

For those that prefer to make charitable gifts annually, it is possible to both get the tax deduction in one year and distribute the funds to charity in the future. This can be accomplished by funding a charitable entity called a Donor Advised Fund (DAF). Making charitable donations with highly appreciated stock remains a very effective way to make your donations whether they are made directly on an annual basis or through a donor advised fund.

For those over age 70 ½, up to $100,000 per year of required individual retirement plan distributions can be directed to charity. In the above example, let’s assume that Harry and Sally are over age 70 ½ and are required to take significant IRA distributions. In lieu of giving $30,000 annually to charity from their non-retirement funds, they may designate $30,000 per year of their required IRA distribution to charity (a qualified charitable distribution (QCD)). By taking this approach their total deductions over the four-year period would be $217,600; a $57,600 increase from the direct annual gift approach merely by changing the source of funds for the charitable gifts.

Save for Retirement

If the past is any indication, it is clear that no one can predict future income tax rates and policy. For those who are currently working and planning for the day when they will rely on their financial assets to maintain their lifestyle, one of the most important ways to plan for an uncertain future tax landscape is to accumulate wealth in a manner that provides for flexibility. The best way to obtain this flexibility is to accumulate wealth in all three forms: taxable accounts, tax free accounts and tax deferred accounts. By accumulating wealth in all three forms you have the flexibility to choose the source of your income in retirement and hence manage your income tax liability. In addition to mitigating taxes, managing your income in retirement can help you manage your Medicare premiums. Medicare premiums vary based on your income and can differ by as much as $4,100 each year.

Because it has only been available for a relatively short time, the after tax (Roth) portion of wealth accumulation is often where people fall short. For a married couple, Roth IRA contributions are not permitted if your adjusted gross income exceeds $206,000. For those that have income in excess of this amount there is a way to circumvent this limitation. There is no income limit for after-tax contributions to a traditional IRA and there are no income limits on converting a traditional IRA to a Roth IRA. As a result, contributions can be made to a traditional IRA on an after-tax basis and subsequently converted to a Roth IRA regardless of your level of income. In the financial planning community this strategy is referred to as the Backdoor Roth IRA and it has recently been recognized by the IRS. This can be a great way to add to the after-tax portion of your wealth over time.