For many federal employees, giving back is part of who you are. Whether you regularly support causes close to your heart, contribute through the Combined Federal Campaign (CFC), or plan to leave a legacy through charitable donations in retirement, your generosity can also play an important role in your financial plan.
Being Charitably Inclined Can Significantly Change Your Tax Strategy
Certain tax moves that make sense for others, like Roth conversions, may not be as beneficial if you intend to give a large portion of your retirement income or assets to charity. Understanding how charitable giving interacts with your income, taxes, and retirement accounts can help you give more effectively while keeping your financial picture balanced.
Why Roth Conversions Aren’t Always the Right Move
Roth conversions are a popular strategy for retirees. By converting pre-tax retirement savings (like your TSP, traditional IRA, or 401(k)) into a Roth IRA, you pay taxes on the converted amount now, then enjoy tax-free growth and withdrawals later.
But that only makes sense if you (or your heirs) will benefit from the tax-free growth down the road. If you plan to donate a significant portion of your retirement savings to charity, a Roth conversion may not be necessary. It could even work against you, because there’s a very important factor that you must remember.
Charities don’t pay taxes!
When a qualified charity receives money from a traditional IRA, they get the full amount, without any tax owed. That means converting to a Roth first (and paying tax on the conversion) doesn’t benefit the charity. In fact, it could cost you extra tax dollars that could have gone to the cause you care about.
Let’s say you plan to leave $100,000 from your IRA to a charitable organization. If you convert that IRA to a Roth first, you’ll pay tax on the $100,000 conversion. But if you donate directly from your traditional IRA, the charity receives the full $100,000, and you avoid the tax bill entirely.
So, if you’re charitably inclined, it’s worth revisiting whether Roth conversions still make sense for you.
How Giving Can Lower Your Taxable Income
Charitable giving doesn’t just make a difference in the world; it can also reduce your taxable income, sometimes significantly.
Here are a few ways that works:
- Itemized Deductions
When you give to qualified charities and itemize your deductions, your contributions reduce your taxable income. If your giving is large enough, it may shift you into a lower tax bracket or reduce taxes on other sources of income, like Social Security or investment withdrawals. - Qualified Charitable Distributions (QCDs)
If you’re age 70½ or older and have an IRA, you can make donations directly from your IRA to a qualified charity—up to $100,000 per year per person.
These Qualified Charitable Distributions (QCDs) are one of the most powerful tools for retirees who give.
Here’s why:
- The donation counts toward your Required Minimum Distribution (RMD).
- The amount is excluded from your taxable income.
- The charity receives the full donation.
QCDs are especially valuable for those who no longer itemize deductions. Even if you take the standard deduction, a QCD still gives you a direct tax benefit by keeping that income off your tax return entirely. The charity receives the complete donation, and the donor’s adjusted gross income (AGI) is reduced, which may also lower taxes on Social Security and Medicare premiums.
Using a Donor-Advised Fund (DAF) to Maximize Impact
If you want more flexibility in how and when you give, a donor-advised fund (DAF) can be a smart vehicle.
Think of a DAF as your personal charitable account. You can make a lump-sum contribution to the fund, and take the tax deduction in the year you make it.
This can be especially useful for:
- Years when your income is unusually high (for instance, after selling property, cashing out unused leave, or taking a one-time bonus).
- Consolidating multiple years of charitable giving into one tax year to exceed the standard deduction threshold.
- Simplifying your recordkeeping by managing all gifts from one place.
You can put cash, stocks, or other things of value into a donor-advised fund. If you give stocks or investments that have gone up in value, you won’t pay taxes on the increase, and you can still get a tax break for the full current value. It’s a great way to combine charitable intent with smart tax planning.
Coordinating Your Charitable Plan with Retirement Income
If you’re nearing or in retirement, think about your income in layers:
- Your FERS annuity
- Social Security
- TSP or IRA withdrawals
- Other investments
Each of these sources is taxed differently. The key is to understand how charitable giving interacts with each one.
For example:
- Giving through QCDs reduces your taxable IRA withdrawals.
- Donating appreciated securities reduces your capital gains exposure.
- Contributing to a DAF during high-income years can help offset taxes from a Roth conversion or lump-sum payout.
By planning your giving strategically, you can potentially reduce taxes on all income sources without changing your level of generosity.
When Giving Changes Your Long-Term Plan
When your giving becomes a meaningful part of your financial life, it may shift your broader retirement strategy in positive ways.
For instance:
- Less taxable income might mean you can stay in a lower tax bracket for longer.
- Roth conversions may no longer be as necessary or may make sense only up to a certain income threshold.
- Estate plans can be simplified by leaving pre-tax assets (like IRAs) to charities and tax-free assets (like Roths or life insurance) to heirs.
Charitable goals should be incorporated into the overall picture rather than addressed separately.
Bringing Your Charitable and Financial Goals Together
Charitable giving is one of the most fulfilling parts of financial planning, but it’s also one of the most misunderstood when it comes to taxes.
The key is to align your generosity with the right strategies:
- Use QCDs if you’re 70½ or older.
- Consider a donor-advised fund to bunch deductions or manage long-term giving.
- Reevaluate Roth conversions if you plan to give a significant portion of your IRA or TSP to charity.
- Coordinate your giving with your income plan to keep taxes as low as possible.
With the right approach, you can support the causes that matter to you while also improving your tax efficiency. This allows you to do more good with the money you’ve earned. For more information on how to maximize your contributions, work with a certified financial planner.
Neil Cain and Evan Radin are certified financial planners with Capital Financial Planners. To discuss your investments, including your TSP, register for a complimentary Retirement Readiness Meeting. For topics covered in even greater depth, see our YouTube Channel.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
