IRA charitable contributions vs. donations of appreciated securities
It’s worth comparing the tax advantages of making an IRA charitable contribution and donating long-term appreciated securities.
One of the most common ways for donors to make an IRA charitable contribution during their lives is a direct transfer of up to $100,000 from an individual retirement account to a charity. Also called a qualified charitable distribution (QCD) or IRA charitable contribution, it’s a way to avoid having to take a required minimum distribution (RMD) on a taxable, non-Roth IRA if you’ve reached the age (70½) where a minimum distribution is mandatory, but you don’t need the funds.
Although there are clear benefits to IRA charitable contributions, not everyone can make them. And it is worth considering whether there might be even more benefits to another popular, tax-savvy donation strategy. A donation of long-term appreciated securities is a direct gift of stocks, bonds, mutual funds or other publicly traded assets to a charity, which can include a donor-advised fund sponsoring organization or foundation.
Benefits for donors and charities
Making an IRA charitable contribution or donating appreciated securities can be strategic for donors seeking to maximize their charitable impact while reducing their tax liabilities. Although there are distinct differences between the two approaches, there is one clear area of common ground: Charities you support using these savvy methods also benefit because it may be possible to make a larger charitable contribution due to the added tax advantages compared to giving cash.
Who can benefit? IRA charitable contributions, or QCDs, benefit donors who don’t want to take their required minimum distribution from an IRA, which are mandatory starting at age 70½. Donations of appreciated securities held for more than a year, in contrast, can provide tax benefits to donors of any age and are not subject to the $100,000 cap for IRA charitable rollovers.
What are the tax advantages? An IRA charitable contribution allows you to meet your RMD requirements without adding to your taxable income. This can potentially keep you in a lower tax bracket and allow you to avoid phaseouts of certain tax deductions that can increase your tax liability.
A donation of appreciated securities, however, also can reduce your taxable income since the full fair-market value of the stock can typically be deducted up to IRS limits. On top of that, donations of appreciated securities allow you to eliminate the capital gains tax that would otherwise be owed when those securities are sold—allowing you to give up to 20 percent more compared with selling the asset first and then donating the proceeds.
In addition, donations of appreciated securities can go to certain kinds of charitable organizations, such as donor-advised funds and private foundations, that aren’t allowed for IRA charitable contributions. Donations of securities to a private foundation are tax deductible to a limit of 20 percent of your adjusted gross income. Gifts of appreciated securities to a donor-advised fund, for example, are deductible up to 30 percent of your adjusted gross income. Donations in excess of that limit may be carried forward for up to five tax years, provided the securities had been held for more than a year before they were given.
A donor-advised fund, like the Giving Account at Fidelity Charitable, is a dedicated charitable investment account that can be used to support charities. You can make a contribution to the charity sponsoring the fund and be eligible for an immediate tax deduction. You can then recommend grants over time to any IRS-qualified public charity on your timetable, and your contributions can be invested for tax-free growth.
Is it right for me? If you don’t need to make a required minimum distribution, it makes sense to instead explore a donation of appreciated securities. This is a simple strategy that can be easily used by anyone with a taxable investment account. However, if you are facing an RMD, you have some additional analysis to do to make the most tax-savvy decision. In many cases, taking the RMD and donating appreciated securities provides a bigger tax benefit, as explained below. Donors should always consult a tax advisor to determine the best strategy for their situation.
Comparing an IRA charitable contribution to a donation of appreciated securities
The example below provides an introduction to a complex charitable giving plan that outlines many financial factors a donor may need to consider. To keep the example simple, a number of assumptions have been built in. Before you make such a decision, you should consult with your tax advisor.
Imagine you purchased securities for $25,000 years ago and those securities are now worth $100,000—a $75,000 appreciation in their value that would be subject to capital gains taxes if they were simply sold. You also have an IRA with a required minimum distribution of $100,000. In each case, the charity receives $100,000.
Here, we assume you are subject to the maximum long-term capital gains tax rate of 20 percent and the 3.8 percent Medicare surtax, and that your income is taxed at the highest marginal rate of 39.6 percent. Here’s what would happen if you took either of two next steps:
What to ask before deciding on a IRA charitable contribution or a donation of appreciated securities
Before deciding how to donate to a charity, there are several questions you should review with your tax advisor to fully understand what the best decision is for you and the charitable cause you want to support.
- Do you have IRAs and are you 70½ or older, and are required to take a minimum distribution? If you don’t, you are not eligible for an IRA charitable contribution and need to consider an alternative.
- Do you own appreciated securities that have created a significant potential capital gains tax liability? One of the main benefits of donating appreciated securities instead of cash is avoiding capital gains taxes on the increased value of the assets in addition to getting the income tax deduction. In addition, you can consider buying back securities you may wish to continue to hold, resetting the basis.
- Is the charity qualified to accept an IRA charitable contribution? Some charities are not eligible to receive QCDs. This includes donor-advised funds, private foundations and supporting organizations as described in IRC Section 509(a)(3). Furthermore, a donor is not allowed to receive a benefit in return for a charitable donation. Some smaller charities may not be equipped to handle QCDs and may prefer to receive contributions via a donor-advised fund.
- Do I want to phase the gift to a charity over time? Sometimes it is better for your chosen charity, particularly small organizations, if you phase a large gift. And sometimes you need more time to decide where you want your funds to be distributed. If so, it may be preferable to make a gift to a donor-advised fund that makes it possible to better time the distribution of funds.
- What would be the impact on your future IRA balances and your investment holdings if you made an IRA charitable contribution or gave appreciated securities? An IRA charitable contribution can reduce your future RMD. A gift of appreciated securities affects the overall composition of your investment portfolio. In some cases, making charitable contributions can help you rebalance a portfolio that has become overweighted in certain areas.
- What are the estate planning implications? Both of these giving strategies can have implications for estate planning. IRAs that are passed on to heirs may be subject to income taxes and estate taxes. Heirs don’t generally owe capital gains taxes on appreciated securities they inherit.