Supercharge Roth Conversions Through DAFs

Welcome to another edition of the what's Next Retirement Podcast with Craig Weir. Life is full of transitions that have a financial impact now and in your future. When finances are affected, there are always questions to ask and choices to make. As an independent certified financial planner for well over 30 years, Craig has helped Americans make decisions that give them their best financial futures. The experiences with so many clients has given him a unique perspective to help with with what's next for you as you navigate the unknowns of your own life. What's next? Answers to the retirement issues on your mind.

Hey there. This is Craig Weir. Welcome back to another episode of Clear Direction for Retirement. I've got some really cool stuff to talk to you about today. I'm excited to share with you, really some really interesting ideas of how to really supercharge your Roth conversion opportunity by actually using donations to make it work. So a couple things that I'll ask on the front end. Do you have plenty of cash and investments and property outside of your ira? That's going to be important part to make this work. Do you have large do you have a large IRA that you really need to convert to an IRA to make sure that you're better off and your your heirs are better off? And key do you enjoy giving to charities? So Pam and I love to give to our church and a couple of other international Christian organizations. And when possible, we really like to give in a way that's also tax smart, if you know what I mean. So the ideas I'm going to share today don't really require contributions in support of a particular faith. They just need to be toward a registered 501 organization to really work out for you. So today I want to show you how to combine all these ideas into a really smart tax saving strategy that you may have never even been exposed to in the past or maybe you heard of, but really didn't know how they work. So I'm going to explain how to make a larger than normal charitable contribution this year or any year to offset a really sizable conversion from your IRA to a Roth this year and in doing so avoid hundreds of thousands of dollars of tax. So it's kind of how do you supercharge your conversion? And if you will just kind of stick around and I'll go through an example of how the math works toward the very end once I've laid out the principles and the foundation. Okay, so one way to incorporate charitable giving in your plans is to convert most of your IRA to a Roth and you leave just enough in the IRA so that once the RMD's required minimum distributions begin, you can use the rules around something called qualified charitable donations or QCDs in the world of acronyms, as it goes to retirement planning. So you can use all the rules around QCDs to avoid tax on those required distributions. So in a QCD, it's a way that you give to your 501c3 organization directly from the IRA and it offsets the required taxable minimum distribution. The limitation with that is that a large IRA is probably going to produce much greater required distributions than you want to donate in a particular year in the future. So relying on just QCDs for the whole balance probably doesn't work. So we like to try to combine all these ideas where you maybe if you are charitably inclined, you do what I'm about to suggest today with a big, big lump, you convert the rest of it down to just an amount that you have just a small amount left where you can easily handle the qualified charitable donations from the RMDs and not have any taxable income after you get the conversion done. So kind of what I'm what I mean by the fact that you may not want to donate that much in a particular year. If you've got a $2 million IRA and this is your first year of RMDs, you got $80,000 you got to distribute this year. And if those investments don't perform at all, that 80,000 RMD goes to 100,000 in five years just because the way that the tables work. And then it goes to 125,000 five years later. I mean, you may want to give 30, $40,000 a year to your charity, but so then you're kind of stuck with the problems that these higher RMDs create. So you like if your RMD is 100 grand and you want to give 40, you still got the extra 60. And then that causes back to the whole problem of why we do Roth conversions in the first place, which is take control when you pay the taxes and minimize the impact of taxation on your Social Security, your Medicare Part B and D premiums, as well as just all the tax that you got to pay on RMDs over the rest of your life. So if you're embarking on Roth conversions, we like to this idea is really that you lump together part of your future charitable giving into a special type of an account or fund and use that to offset a large Roth conversion. So a donor advised fund or daft, if we're going to stick with all the Acronyms here acts as kind of a charitable giving account for you and your family, you know, for individuals and families that are charitable, and you look to maximize your impact and tax benefits. Then donor advised funds have really become very popular ways to support charitable causes. In fact, they're really simple and they're very flexible. And because of that, they've become some of the fastest growing charitable giving vehicles in the United States. There's an organization called the National Philanthropic Trust, and they reported that donor advised fund activity actually went up in 2022 to a total of like $52 billion of donations. And in 2023 they increased by another 9 or 10%. And so they've become very popular way for people who do support charities to be able to get all the benefits. I just said, so what is a donor advised fund? How does it work? Let's start there. So a donor advised fund acts as kind of a charitable giving account for you. And you can contribute all kinds of assets. You can give cash, you can give stock, you can give real estate, crypto, private equity, mutual funds, retirement assets, all kinds of things. You start by just opening a donor advised fund by one of the sponsors, like a Fidelity, Schwab, Vanguard, and then there's a host of others out there. When you open that donor, that donor advised fund, you actually are making a tax deductible contribution. So whether you donate cash or your Apple stock that's gone way up, or your Tesla stock that's gone way up, or real estate, or, you know, whatever the case is, if you donate that to the donor advice fund, it's maintained and it's operated by that sponsoring organization, your contribution then is eligible for an immediate tax deduction at the time that your gift is made. So the second part of this is now you have money in the account and it grows. You can choose a variety of investment options that the sponsors make available to you. And just use your imagination, what's available at Vanguard, Schwab, Fidelity, all those. But once it's in that donor advised fund, it grows tax free while you kind of sit back and decide which organizations you're going to support, when you're going to support them, how much you're going to support them, you have total control over that part of it. The only thing is that they have to be recognized 501c3 organizations by the IRS. And so you have a variety of investment options inside those different accounts. And then you decide when you want to make the donation. You literally have a checkbook. If you want to use a checkbook or you can actually do it anonymous, you can direct them to give it anonymously. Also, there's a few rules and contribution limits that we probably need to talk about. Each of these sponsoring organizations, like a Fidelity, Schwab Vanguard, they all have different sets of rules for donor advised funds that you need to check into. They're pretty standard and they're pretty much the same across the board. But read the fine print, learn what limitations, if any, that they put on that. But the thing to understand is that your contributions to these donor advised funds, I mean they're irrevocable, they're gone, meaning the you have given it, you have gifted it to into this donor advised fund, you just get to delay when you direct it to the specific organization that you want it to go to. The cool thing is there are no contribution limits on how much you can donate to a donor advised fund. Some of the sponsors may require a minimum that they want you to have to get it started. But there's for practical purposes, there's really not any real minimums or maximums. But the grants that you make once the money gets into that donor advised fund have to go to a public 501c3 organization, as I said, that's registered or recognized by the irs. You can't make grants to Aunt Sally or to your kid who's in college. You can't give it to the grandkids. They can fund scholarship opportunities, but they're based on a very strict defined set of student criteria. And I haven't looked into this in detail, but I don't think that you can actually make it available to your grandkids. Donors cannot receive any personal benefit from the grant making or it invalidates the whole thing. So donor advised fund tax deductions are kind of the big reason that you do these. They're not only are they flexible in that you can put the money in now and wait and decide who you write the check to, but there's huge tax benefits, as I've already mentioned. So immediately following when you make the contributions, you're eligible for a tax deduction that year. And it's similar to any other charity. If you donate cash to a charity, you can deduct up to 60% of your adjusted gross income. So if you put 100,000 or 500,000 or 2 million into a donor advised fund, you can put an unlimited amount in there, but in the year you make the contribution, you're limited to just 60% of your adjusted gross income. And I've got an example in a few minutes I'll share with you. That'll make that, that'll have, that makes sense. Donating long term appreciated stock or other types of securities can also help, but you are limited to you get the full fair market value of that item. So if you're donating highly appreciated Apple stock and it's, you got $200,000 in that stock, you can take full market value, but that that year, in the year that you donate it only 30%, you can only use that Apple stock for 30% of your adjusted gross income. Now the good news is you can carry forward all those extra contributions for up to five years. So you want to really get a good game plan on how you do that. But the cool thing about donating assets that have gone up a lot is that you totally eliminate the capital gains tax on those long term appreciated assets. Now you've given them, you get a tax deduction and you avoid paying the tax on the gain. Now you've also gifted it, so it's gone. But if you're going to give it anyway, here's a tax efficient way of doing it. And when you combine it with a Roth conversion like I'm going to show you in a minute, it makes it really cool. So donations, as I've already said, when you just to restate it, even though you're maybe limited to 60% of your adjusted gross income for cash donations, anything above that that's remaining, you can actually carry it forward for up to five tax years. So in addition to the tax deductions, some of the other benefits are you do get to keep it invested into whatever types of funds and programs the sponsors have available. Some of them are self directed, some of them, they want you to use their management services and they grow over time. You get to stay actively engaged in writing the checks and making the grants to the organizations you want. And you do it on your own time frame, when you're ready and the dollar amounts that you want to, it's just a pot of money sitting there that you've already received a tax donation for. You just get to decide when and how much you want to give to them. So the other thing is a lot of people use it to kind of support a family philanthropy. So they put a large amount of money in there. And I've got, we've got one set of clients that they have family meetings and everybody decides where they want it to go. And it's mom and dad's way of teaching the next generations how to, how to really manage that money. And how to make decisions on where they give the money to. So let me give you a real quick example of how it could work. I'm going to keep it really simple just because I'm speaking this instead of a whiteboard or something like that. So let's say you have a half a million dollars sitting in a money market account and it's over in your brokerage account and you got like a million and a half in IRAs that you've determined really needs to get converted. And let's say you've got a game plan that says you need to convert $200,000 a year. And one other. Two other pieces of information are important. One is your adjusted gross income from all your other sources. When you take your pension, Social Security, other investment income, let's say this year your adjusted gross income is going to be $150,000. That's going to be a key in the calculation. So the other important thing is you usually give to charities and you're going to continue to do so in the future. If you don't give to, there's no reason to do this right? You're just giving your money into something that is for naught. So, but, so this is really a good strategy for those of us that we know we're going to keep giving. We just want to use it in a real tax efficient way because we also want to get that IRA over to a tax free state as soon as we possibly can. So if you, so your AGI is going to be 150, you're going to convert $200,000. So now you got another $200,000 of taxable income added on top of that. So now your AGI is 350,000. So remember, let's say you gave cash, so you can, you can take 60% of that 350,000 this year. So that's.038. That's $210,000 is what you can deduct. So you open up a donor advised account for 200,000. That's the amount that you're going to put into the donor advised fund. And you convert 200,000 from your IRA to your Roth. That doesn't have to be the same number. I'm just showing you how the math works on it. So you get to deduct roughly 210,000 this year. You converted 200, you deduct 210 and you've got a pot now sitting there of 200,000 for future donations. And you've got 200,000 from the IRA over to the Roth at zero tax on the conversion. Isn't that cool? Give you one other simple example. So let's say you have a donor advised fund and you put 500,000 into it and you convert 400,000 of your IRA. And so that makes your adjusted gross income 150 plus the 400 that you converted is now 550. That means you can deduct 330,000 and you can carry forward the rest of the 400 that, that you made the donation. I mean the 500 that you made the donation. The difference between the 500 and 330, you get to carry it forward in each of the next five years. So your taxable conversion was the difference between the 400 and the 330. So you're only going to pay tax on 70,000 of a $400,000 conversion. Alright, so I went through that kind of quick, but hopefully some of that made sense. I mean, the bottom line to it is if you combine charitable donations with Roth conversion, at the same time, there's some spectacular things that you can use to save taxes. If you're going to give the money anyway over your lifetime, you just accelerate when you get the deduction for it. And you know, unless the tax rates change significantly, you're actually doing it at higher tax rates, getting a higher benefit now than if you just string it along over the rest of your lifetime. So I'll say, you know, a warning to you is all this is really best completed with the coordination of several people. My recommendation is you use somebody that's a Roth specialist to put together the game plan. Of course, that's what we do. And so we're kind of biased and that we think that you really need to have a very coordinated plan to put all these working pieces together in the right way. The other thing is you want to bring, if you have it, you want to bring your investment advisor in after you've done the work, got the game plan, and let them help you with the implementation of which assets and that kind of thing. And of course you always want to bring the CPA or whoever does your taxes in, if for no other reason, just to have them double check the numbers based on your personal situation. You want to make sure that, you know, all the I's are dotted and the T's are crossed. So if you don't have a Roth conversion game plan, that's really the first place to begin. You can talk to somebody, whether it's one of our CFPs or somebody that you're using on the other side and find out what's really going to be best for you. There will be, there'll be links in the show, notes that you can learn more about what we do for our clients. Probably it's a link to a webinar that we've done that you can learn kind of why you convert, what the mistakes are that people make. And you know, if you like this kind of content that I'm putting out there for you today, just click the subscribe button to the podcast and every time we do a new one of these, you'll get kind of that little pop up says, hey Craig, put some more stuff out there for you. We're putting out new information now on a weekly basis and that way you'll be among the first to know. So I appreciate you taking a few minutes today. I hope that was helpful. You have learned how to supercharge your Roth conversion strategy. Take care. Have a great day.

Investment Advisory Services offered through Q3 Advisors this presentation is for educational and informational purposes only and is not intended to be individualized financial, tax or investment advice.