By Austin Kilham, www.WSJ.com
May 22, 2014 11:44 a.m. ET
When the couple approached financial adviser David Munn in 2013, they were two years from retirement and wanted to be as efficient as possible with their money in their final working years.
The couple had been diligent savers and had robust income from the husband’s $120,000 annual salary, plus his partnership stake in a company that made yearly distributions to the partners.
In fact, the K-1 income for the husband’s stake was only problem the couple seemed to face: It often bumped them into a higher tax bracket. Although the company also made distributions to cover its partners’ increased income taxes, the couple was concerned about these big tax bills.
When Mr. Munn then asked about their retirement plans, he saw an opportunity to reduce that tax burden. “The couple was financially beyond where they need to be to retire comfortably, and they had a desire to do a significant amount of charitable giving while living,” says Mr. Munn of Munn Wealth Management, which manages $304 million for 2,500 clients in Maumee, Ohio.
Mr. Munn suggested that rather than waiting until retirement, the couple could start its charitable giving now by creating a donor advised fund (DAF). Then, he explained they could use the husband’s annual K-1 income to make contributions to the fund, reducing the additional income tax they owed on those earnings each year. The strategy would keep them in a lower tax bracket preretirement, and provide a pool of money to donate to charities after they retired.
He warned the couple that any assets placed in a DAF would no longer be available to them for any use other than charitable giving. But they were confident in the amount they had saved and recognized the tax benefits of the plan, so they asked Mr. Munn to set up a fund for them.
Mr. Munn advised them to wait until the end of the year to make their first contribution to the fund, so they would have a good estimate of their cash flow, annual K-1 income and the size of the additional distribution to help cover income taxes. After reviewing that information at the end of the year, Mr. Munn determined that the couple could afford to contribute $50,000 to the fund in 2013.
Although that contribution did not completely offset the K-1 income, the deduction they received was enough to bring the couple down from the 33% tax bracket to the 27% tax bracket, saving them $17,000 in taxes that year. The couple will repeat the process in 2014, which likely will be the last year the couple contributes to the fund. Once the husband retires in 2015, the couple’s annual income will be significantly lower and there will be less need for the large tax deduction.
The couple was thrilled to reduce their taxes while putting part of their annual K-1 income toward their future charitable goals. They only wish that they had started years earlier, Mr. Munn says.
“This is a great technique for clients with high income who have more than enough to live off of in retirement, or have appreciated non-qualified assets where they can avoid capital-gains taxes and get a full tax deduction,” he says.