(Dow Jones) Bulking up on charitable donations is one strategy some financial advisors are recommending this year to clients facing a tax hit from moving retirement assets to Roth IRAs.
The tactic may be especially suitable for those who had plans to give in coming years anyway. Vehicles such as donor-advised funds allow the donation to count against this year's taxes but to be doled out to specific charities in future years.
This is the first year that individuals earning more than $100,000 can use Roth IRAs, which have a special appeal with income tax rates expected to rise next year and in the future. Taxes are paid now on income and savings put into Roth IRAs, while growth is tax-free. But a big conversion of pre-tax retirement accounts into a Roth means a big boost in reported income this year and a hefty tax bill to go with it.
Calculating when and how to best roll over money into a Roth can be complex, with factors including other savings and income, age and years to retirement--not to mention whether someone has the money to pay the taxes. Making charitable contributions also can involve complicated financial calculations and projections; donations made now mean less to deduct in future years when taxes are higher and the impact of a deduction is likely to be greater.
Still, advisors said that, in many cases, wealthy investors would be better off rolling over all they can in 2010 and making larger donations now to reduce the impact of higher taxes later.
"We're advising clients to consider everything," says Brittney Saks, a Personal Financial Services partner in the Private Company Services Group of PricewaterhouseCoopers in Chicago. "A lot of people have large balances and this is significant."
There are other ways to offset taxes, such as business losses for those that have them. Saks pointed out that business losses must be deducted the year of the loss, while deductions for charitable donations can be stretched out over five years.
She also noted that there are limits on charitable deductions--generally 50% of yearly gross income for cash donations and 30% for donations of stock.
And the deductions, while helping to reduce the tax bill, typically won't eliminate it completely. For example, if someone is rolling over $850,000 from a traditional IRA into a Roth IRA, they could expect to pay $286,545 in taxes, according to Fidelity Investments. That tax bill would drop by $73,850 if they make the same year a $211,000 contribution. However, in some cases the reduction could be enough to keep someone in a lower tax bracket.
Christine Fahlund, a senior financial planner at T. Rowe Price, encourages people planning to do the rollover to consider making a larger than normal contribution to a donor advised fund if they don't have a charity in mind. Investors get to use the tax deduction the year they donate to the fund but can later choose what nonprofits should receive the donations.