Tax planning is a critical aspect of financial planning in retirement.
Proper tax planning can make a huge difference when it comes to how much of your hard-earned retirement savings you’ll owe in taxes each year, which can, in turn, trickle down into other areas of your financial life, including your budget, spending, and plans for the future.
In 2017 the Tax Cuts and Jobs Act nearly doubled the standard deduction. As a result 87% of tax filers utilized the standard deduction in 2019. However, there are still ways that you can reduce your tax bill in retirement including donor-advised funds and qualified charitable distributions.
What Is the Standard Deduction?
The standard deduction is a set deduction that reduces your taxable income. The exact amount that you’re eligible for varies depending on your age, income, marital status, and whether or not you’re blind, among other factors. In 2021, the standard deduction is:
- $12,550 for a single filer
- $25,100 for a married couple filing jointly
- $18,800 for a head of household
Unlike other types of deductions, you don’t need to do anything to qualify for the standard deduction—you simply take it.
Even if you take the standard deductions, there are other strategies you can use to maximize your return. These include:
- Donor-Advised Funds (DAF)
- Qualified Charitable Distributions (QCD)
- Bundling charitable giving
What is a DAF?
A donor-advised fund is one way retirees who usually take the standard deduction can lessen their taxable income via charitable giving in certain years. To use a DAF, you must first open an account and deposit funds. You’ll immediately receive an itemized charitable tax deduction based on the amount you contribute. You will want to use this strategy in a year where it will help your aggregate itemized deductions rise above the level of the standard deduction. Plus, you can feel good about supporting the charities and organizations that are important to you!
Once you contribute, you’ll no longer have access to the funds, and you won’t be able to withdraw them in the future or use them for another purpose. However, you can invest the funds and recommend grants to charities of your choosing over time. You can use the funds in a DAF to support any IRS-qualified public charity.
A DAF is also worth considering as a component of your estate plan for retirees looking to begin the estate planning process. You can nominate an individual or a specific charity to be the successor to your DAF account. They can continue to administer your fund and help you to create a charitable legacy.
What is a QCD?
QCDs are another way that retirees can reduce their taxable income and lower their tax burden while also contributing to charity. QCD stands for qualified charitable distribution. These contributions are made from IRAs to qualifying 501(c)(3) organizations, and both traditional and rollover IRAs are eligible. QCDs count towards your required minimum distribution, which means you can employ this strategy to lower your taxable income for the year.
However, there are a few rules to keep in mind when using a QCD.
- You must be at least 70 and ½ to take advantage of a QCD.
- $100,000 is the maximum amount you can use to make a QCD (per individual, so a married couple could have a total of $200,000 in QCDs).
- You can contribute more than the required minimum distribution, but contributions over the RMD won’t lower your taxable income.
QCDs can be used when you use the standard deduction or in years that you itemize.
What is “Bundling”?
Bundling is another strategy that retirees can use to increase itemized deductions to reduce their tax burden. You can “bundle” giving to donate a large amount of cash, appreciated assets, or other property in one year and maximize the tax deduction.
Using this strategy, you may not contribute to charity every year. Instead, you’ll “bundle” contributions to donate a more considerable amount of funds in one year, lowering your taxable income and reaping more significant tax benefits as a result.
Stay Tax-Conscious Even With The Standard Deduction
Taking the standard deduction when filing a tax return will make the most sense for many retirees, especially if you don’t qualify for any special deductions that might make itemizing worthwhile (mortgage interest, student loan interest, etc.).
But just because you take the standard deduction, it doesn’t mean that you can’t still optimize your tax situation to make the most of your finances while also supporting your favorite charitable organizations.
Charitable giving through DAFs, QCDs and bundling are all great ways to lower your tax burden. Before and during retirement, conducting appropriate tax planning can help you minimize the taxes you owe and set yourself up for future success.
If you’re nearing or in retirement and looking for advice, we’d love to help. Get in touch with us today to learn more about our services!