Charitable clumping (or bunching) is a tax optimization technique commonly recommended by financial planners to the wealthy, especially since the standard deduction was substantially raised in 2017 making it harder to itemize deductions. But charitable clumping can work for generous young professionals too. I may have already hinted at this technique to some of you if you expressed an interest in charitable giving. But in this article, I explain how it works in more detail. If I can help you get a tax deduction for your donations, you can use the savings to give even more or augment your own discretionary spending. The savings can be substantial.
Background on Charitable Clumping
With the last tax reform, the standard deduction we all get on our taxes was substantially raised. It’s so high right now that only around 10% of households can get a greater tax break by itemizing their deductions. Even many homeowners haven’t been itemizing because they haven’t been paying enough mortgage interest (for today’s buyers, it’s a different story!). That means, for most people, their charitable donations have not been tax deductible (except for a few years when a small-dollar charitable deduction was permitted even for those using the standard deduction).
After 2025, Things May Change
Several elements of the most recent tax reform are scheduled to sunset after 2025. Assuming the changes are not renewed, the standard deduction will drop back down, some limits on deducting state and local taxes will go away, and importantly, the tax rates in most brackets will increase at the federal level. Since at that point it will be both much easier to get over the standard deduction by itemizing and tax rates will be higher, consider this strategy: Instead of making charitable donations every year right now, invest the money temporarily, and bunch your donations all in years after 2025.
Now if the tax changes are renewed, then the target years for clumping would shift to when your total deductions are projected to be to exceed your standard deduction so that most if not all your charitable giving will be deductible. Most likely this will occur once you pay enough mortgage interest and property tax.
And you save even more on your taxes donating the smart way—with securities instead of cash. If I’m managing your investments, when it comes time to make an oversized bunched donation (or any donation), I’ll comb through your taxable accounts and identify the securities or lots of securities with the highest unrealized gains so you can donate those in lieu of cash. Now you avoid the tax on those gains too. And the charity doesn’t care; it will simply sell the securities immediately and pay no tax as a nonprofit, so it’s the same as cash to them.
Charitable Bunching for Existing Itemizers
Charitable bunching is most relevant to those clients who cannot currently itemize deductions on their taxes. For those of you who can already, charitable clumping matters less—unless there is a “spike year” somewhere in your financial plan where we expect higher-than-normal income pushing you up into a higher tax bracket. If such a spike exists, I might suggest you pursue charitable clumping but target that specific year (or years) as deductions will potentially have the highest dollar benefit for you by smoothing your year-to-year taxable income.
The Potential Benefit of Charitable Bunching
In the exhibit below, I show just how impactful this strategy can be:
I only model a single tax filer here. Couples may need to donate more depending on what tax bracket their total income lands them in to obtain a similar-sized result. But it’s possible that just this one technique (me devising a personal giving plan for you that includes charitable clumping) can offset years of my planning fee. And I’m still adding value in many other ways. By the way, this analysis excludes any tax savings from donating appreciated securities, so it’s possibly understating the benefits of the charitable clumping strategy.
Want to discuss your specific case? Set up a time to talk, shoot me an email, or give me a call. I’m here to educate, assist, and serve.
All content presented in this article is for informational purposes only. Materials presented should not be interpreted as a solicitation or offer to buy or sell a security or the rendering of personalized investment advice, which can only be provided through one-on-one communication with a financial advisor. The content reflects the opinions of Hesperian Wealth LLC (HW), which are subject to change at any time without notice. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All information or ideas provided should be discussed in detail with a financial, tax, or legal advisor prior to implementation.
Any reference to a market index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indexes are unmanaged vehicles that do not account for the deduction of fees and expenses generally associated with investable products.
Investing involves substantial risk, including the potential loss of principal. HW makes no guarantee of financial performance nor any promise of any results that may be obtained from relying on the information presented. HW may analyze past performance, but past performance may not be indicative of future performance.
1 Assumptions used in Charitable Clumping model:
- State & Local Taxes: estimated California state income tax based on $100,000 adjusted gross income, adjusted each year by 3% for inflation, assumes SALT limitation sunsets after 2025
- Projected Standard Deduction: projections from RightCapital, assuming TCJA rules sunset after 2025