Charitable planning and philanthropy can play a key role in reducing the tax burden when advisors help clients who converting an IRA into a Roth IRA.
Roth conversions may make sense if a client faces higher taxes when he starts withdrawing funds. In addition, a Roth conversion can increase the amount available to heirs. Since there are no minimum distribution requirements during the owner’s lifetime, more money can remain in a Roth account to grow, tax free, for a bequest.
Heirs to Roth IRAs are required to make distributions. However, the earnings are exempt from federal income tax as long as the account was opened five years before the first withdrawal. These distributions can continue for an heir’s lifetime and the balance of funds can continue to earn returns tax free.
A charitable gift of non-IRA assets can also be a great way to help offset taxes resulting from a Roth conversion and support philanthropic causes at the same time. For clients who are planning to make charitable donations in the future, they might consider accelerating their giving in the year of the Roth conversion.
So how does your Roth-holding client get a benefit?
One way to get an instant tax deduction for charitable giving is through a donor-advised fund. Contributions to donor-advised accounts are irrevocable and must go to charity. While the tax benefit is immediate, the charitable grants can be distributed over time. This allows clients to make decisions about grants to desired charities as they see fit. The DAF sponsor handles all the administrative details, leaving the client to focus on the more enjoyable aspects of philanthropy.
In another noteworthy benefit, clients who give gifts of appreciated securities held for more than one year avoid capital gains taxes when they’re sold. This means that donors may be able to gift up to 20% more of their holdings to charity.
Unfortunately, many charities can’t process non-cash gifts, including appreciated securities, C- and S-corporation stock, and real estate. There are DAFs, on the other hand, that accept these types of assets. They sell the assets, put the cash proceeds in the donor-advised account, and provide all the necessary paperwork for tax filings.
Charitable planning and philanthropy can be key components of larger financial planning efforts. DAFs in particular can provide a simple, tax-smart way to help with retirement savings or reduce income taxes or minimize estate taxes for heirs, all while letting a client build a legacy that outlives them.
Kim Laughton is president of Schwab Charitable, a national donor-advised fund with a mission to increase charitable giving nationwide by making charitable giving accessible, flexible and simple for individuals, families and their advisors. Serving a wide range of philanthropic investors, Schwab Charitable’s account sizes range from $5,000 to more than $500 million.