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WITH DECEMBER FAST approaching, it’s a good time to think about end-of-the-year financial planning. What steps might you take?
A popular strategy is to make charitable gifts, both to support good causes and reap a tax benefit. But before you start writing checks, take a moment to better understand your tax picture. Because of the complexity of tax forms, that’s often easier said than done. Still, you don’t need to decipher every number. Instead, I recommend focusing on what I call “the big three” questions on your tax return:
If you know these three pieces of information, they’ll provide, in my view, most of what you’d want to know. More to the point, they’ll provide most of what’s important in making tax-related decisions. The good news: Most tax software programs provide answers to these three questions on a simple summary page. If you work with an accountant, he or she can also provide this information.
With answers in hand, you can turn back to the question of charitable giving. What’s the most tax-advantaged way to give? Here, you’ll want to consult the first of the above questions: Are you itemizing deductions? If you aren’t itemizing, an incremental charitable gift—while certainly helpful to the charity—won’t offer any tax benefit to you.
For that reason, if you’re in the neighborhood of the threshold for itemizing but not quite there, a strategy to consider is “bunching” deductions using a donor-advised fund. The idea is to double up on donations every other year, allowing your deductions to exceed the standard deduction in those years, and potentially offering tax savings equal to your marginal income-tax bracket. I mapped out this strategy a while back, when the current rules were put in place.
This is also a good time of year to think about gifts to family members. If this is a priority for you, there are a few aspects to consider. First are the tax considerations, though these are fairly straightforward. As you may know, there’s an annual exclusion for making gifts.
In 2023, the exclusion allows you to give any individual up to $17,000 without any gift or estate tax impact. In addition, there’s a lifetime exclusion, which is close to $13 million per person, though that figure is currently scheduled to drop by half in 2026. In addition, if you’ll need to sell investments to fund these gifts, it’s helpful to know your capital-gains tax rate.
Those are the quantitative considerations, and they’re certainly important. But a far more difficult question, in my view, isn’t quantitative at all. That question is, how do you structure gifts to family members in a way that doesn’t cause unintended consequences? If you’re thinking about a program of gifting to children or other family members, I would consider the following:
Scale. Warren Buffett has noted that his strategy in making gifts to his children was based on a simple principle: He wanted his children “to have enough that they could do anything, but not so much that they could do nothing.” This makes sense, and it highlights a key challenge in making gifts. You don’t want the recipient to lose the motivation to get out of bed in the morning. And because everyone’s situation is different, there’s no universal rule here.
Not sure how much is too much? I suggest starting with modest gifts and increasing them only when you can see that the funds are being used productively. Alternatively, you could make gifts that are restricted in one way or another. For instance, you could make a gift to a 529 account, to a custodial account or directly to a family member’s IRA. In each case, the funds could be withdrawn and used in ways that run counter to your expectations, but it would be more difficult. For greater control—especially if you have a larger estate—you might establish a trust and make gifts only through that vehicle.
Sustainability. It likely goes without saying, but it’s important to be sure the gifts you make don’t jeopardize your own financial plan. That’s another reason you might make gifts that increase only incrementally over time.
Transparency. If you’re making gifts to children or to other relatives, chances are they won’t ask too many questions. But that doesn’t mean they won’t have questions. They might wonder, for example, if they can expect further gifts, and what those might look like. That’s why I recommend being transparent with recipients. Let them know your intentions, so they face fewer unknowns in making their own financial plans. If you’re not sure yet whether you intend to make further gifts, that’s okay. Letting recipients know that there’s uncertainty is still helpful information.
Consistency. More than once, I’ve worked with the recipients of gifts who were left puzzled and a little uneasy. That’s because the gifts they received varied in size each year. The recipients were left to wonder whether the differences from year to year—especially when the gifts decreased in size—were meant to send a message. In most cases, the annual differences had benign explanations. In years when the market declined, for example, I’ve seen parents make smaller gifts. The problem, though, is that recipients didn’t always know that. That’s why, if you decide to make ongoing gifts, I suggest starting at a level you know you can maintain through any economic environment.
Equity. I have yet to meet two siblings whose financial situations were identical. But if you’re making gifts to children or grandchildren, I suggest not treating them any differently.
Suppose you have two children, one of whom is a schoolteacher and the other a brain surgeon. Even in that case, I think the best path is to treat them the same. Why? As I often say, brain surgeons have feelings, too. In addition, it’s important to not make assumptions about others’ financial needs. Those with high incomes not only face steeper tax bills, but also their family will receive less college-financial aid and they may have other financial obligations. Result? Their actual disposable income may be far less than it appears.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.
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Thanks so much, Adam. The timing of this article was perfect for me: I’m hoping to set up a donor-advised fund for charitable giving very soon and will consider the “bunching” technique, after speaking to the accountant who does my taxes. Will add the “big three” questions to my list for him. I always give him receipts to itemize, but will check my returns to see if he used them or went with the standard deduction. I know I should know this but I’m learning, HD article by HD article. 😊
Very informative and useful article, Adam. In regards to equity, I remember many years ago, when my father was still alive, he devised a complex formula to divide his and Mom’s estate among their four children, based on his perception of our financial situations. I appreciated his efforts to be fair, but suggested that one of my younger sibs was not as well off as he imagined, and to leave her nothing might send an unintended message. I persuaded him to simply divide his estate evenly among my three younger sibs, and I would be happy with a nominal $100 inheritance, and would serve as administrator. The irony was that his estate was quite modest, and had my mother survived just a few more years than she had, there would have been no estate left. The bigger irony was that two of my sibs passed away after my father had, so when my Mom passed, only one sister and I survived her.
Your analogy of the neurosurgeon and teacher is a good one. First, our perception of someone’s wealth could be way off. My wife and I have two sons, both married. We know their personal financial situations are different, but then we don’t have all the facts. Much more importantly, we don’t know what the future holds. We will leave each of them half, and believe that whatever happens, they will have each other’s back.
Jack, your examples describe so many common unknowns and the dangers of making assumptions: my cousin was left out of a childless uncle’s will because of the belief that his wife would receive a substantial inheritance from her grandmother, due to her mom’s estrangement from said grandmother. By the time my uncle died, my cousin was divorced, plus the ex-wife’s mother had reconciled with the rich grandmother. In my immediate family, there have been revelations and assumptions that make your “divide equally regardless of what you think you know” the best rule to follow. Thanks for helping me with my own estate planning.
Equity between siblings is best. Too often people financially bail out a spendthrift, underemployed child. While the more prudent, hardworking sibling gets nothing.
I was going to make a quip about government programs here, but then I thought better of it…
Followed by resentment and hard feelings 🙁
Note that at age 70-1/2 one can begin a process called Qualified Charitable Distributions from your IRA even though you are not subject to RMD until you reach 72. This is helpful if you are attempting to manage your overall tax situation. The QCD must go directly to the charity.
“The QCD must go directly to the charity.”
Note that the way some IRA managers (e.g., Vanguard) handle “go directly” is to make the QCD check payable to the charity but send the check to you, and then you send it to the charity.
I initially ran into that. I use Schwab, and my financial advisor told me that – – – the check would be written to my church, but it would be sent to me. I pushed back, as I didn’t want to be the middleman in the process – especially if I’m traveling. My FA spoke to folks at Schwab and they agreed to send the check directly to my church.
Adam, how to be a helpful giver can be more difficult than it first appears. In my personal life, and in having a hand in directing benevolent giving within my church, I’ve had doubts about the best course to follow. Money gifts can change relationships, and do harm as well as good. Starting modestly is good advice.