Maximizing retirement contributions is a great way to increase your lifetime legacy giving – here’s how to do it.
If you’ve spent much time on this blog, or are a client of Charis Legacy Partners, you’ve likely heard me talk about laying the foundation for maximizing lifetime giving through increasing the legacy giving return on investment (ROI) of our wealth. In other words, we want to increase our wealth surplus, which we can then funnel to the charitable causes we wish to support. Increasing charitable ROI is about both accumulating assets and minimizing taxes (since every dollar you pay in taxes is one less dollar that you could put towards legacy giving). Due to the time horizon (amount of time your money is invested) and the potential tax advantages of retirement savings accounts, pre-tax retirement contributions are a great option for increasing ROI.
Employee-Sponsored Retirement Savings Plans
Maximizing pre-tax retirement contributions is most commonly achieved through contributing to workplace 401k or 403b plans, if offered by your employer. For married couples where both spouses work, both spouses may contribute to their respective 401k or 403b plans. After leaving that employer or retiring, this money can be then rolled over to an IRA, making it available to be used for Qualified Charitable Distributions (QCDs – which I’ll get into in more depth later in this post).
For relatively low earners, start by just contributing enough to get your full employer match (assuming there is one), otherwise you are leaving free money on the table. And you’re not just missing out on the amount your employer matches, you’re also missing out on all the potential compound growth from that money. The younger you are, the more time you have to let the power of compound growth work its magic, so though you may earn less earlier in your career, you should prioritize maxing out your employer match in these years.
Again, the idea is to leverage the employer match to get a higher ROI on your investment dollars, which translates to increased wealth surplus available for legacy giving in retirement.
Contribution Limits
As discretionary income increases, you can increase your retirement contributions beyond the employer match, up to the annual pre-tax contribution limit. In 2021 the limit is $19,500, plus $6,500 catchup contribution for folks age 50 and over, though these contribution limits are periodically adjusted for cost of living, so make sure to review the limits each year.
For high earners with the ability to save even beyond these limits, you can still make non-deductible contributions, up to the combined employer and employee contribution limit of $58K, assuming your employer allows it. These non-deductible contributions are post-tax, but the earnings on them are pre-tax.
This then provides you with two opportunities – as the earnings compound over time, they can be used for QCDs in retirement, while the post-tax contributions can be rolled over to a Roth IRA. I’ll quickly touch on why both of these options are ideal for increasing legacy giving ROI.
Qualified Charitable Distributions
One of the most powerful charitable giving incentives in the tax code is Qualified Charitable Distributions (QCDs) from pre-tax (i.e. Traditional and Rollover) Individual Retirement Accounts (IRAs). In retirement, starting at age 70½, you can make up to $100K per year of charitable donations from your pre-tax retirement savings. Essentially, what this means is you are taking money that has never been taxed, growing it tax-deferred, then giving that compounded growth to charity, at which point you get another tax-deduction, thereby avoiding taxation on those distributions.
This means you’re getting a triple tax benefit (as opposed to the double tax benefit Traditional and Roth IRA contributions both receive). We are now getting to a point of leveraging not just the power of compound growth or even tax-deferred compound growth, but of tax-free compound growth, to super-size your lifetime giving impact.
Another reason QCDs are so powerful is because they count toward your Required Minimum Distributions (RMDs). This allows you to divert large swaths of your pre-tax IRA money to charitable giving each year, leaving post-tax money to meet any inheritance goals. And QCDs are an “above the line” deduction rather than an itemized deduction, meaning you can benefit from the standard deduction and still get the full tax benefit of your charitable gifts. Furthermore, because QCDs don’t increase your adjusted gross income (AGI), they avoid pushing you into higher tax brackets.
Rolling Over Post-Tax Contributions to a Roth IRA
When you make non-deductible contributions your post-tax contributions can be rolled over to a Roth IRA. This is known as a “mega backdoor Roth” strategy. A backdoor Roth strategy is when you make contributions to a traditional IRA (these are after-tax contributions) and then you convert your Traditional IRA into a Roth IRA. A mega backdoor strategy is the same thing, but just using the contributions to your employer’s 401(k) plan above the annual pre-tax contribution limits (which are much larger amounts than Roth IRA contribution limits, hence the “mega” part). In order for this strategy to work though, your employer must allow after-tax non-Roth contributions.
Who This Strategy Works Best For
One caveat here: by saving with non-deductible contributions into an IRA as opposed to saving into a regular taxable account, the earnings will be taxed as ordinary income rather than capital gains, which are taxed at lower rates than ordinary income. Because of this, many tax accountants will advise you against doing non-deductible IRA contributions. But, if you have strong charitable goals and will be using this money for QCDs, what rate the earnings are taxed at is not a concern because the distributions will be tax-free anyway.
If your legacy goals more strongly prioritize heirs and loved ones, this strategy may not be the best approach. As always, you should speak with a tax professional for personalized tax advice.
Spousal IRA Contributions
One final note on maximizing pre-tax retirement contributions – if you’re married and one spouse is not employed outside of the home, that doesn’t mean they can’t also be saving for retirement.
In the case of a married couple where only one spouse earns income, the working spouse can still make what are called “spousal IRA contributions” on behalf of their non-working spouse. So long as the couple files taxes jointly and total earned income is above the annual contribution limit for both spouses combined, both spouses can max out their IRA contributions for the year.
The Takeaway
To increase our legacy giving ROI we need to consider ways to minimize taxes while accumulating assets, and maximizing pre-tax retirement contributions is a great way to do that. If you’re interested in learning more about retirement savings or creating a personalized plan to maximize legacy giving ROI, we’d love to hear from you. Feel free to schedule an initial consultation using the button in the navigation menu.