A financial plan for early retirement should include a concrete strategy for ongoing philanthropic involvement.
The concept of early retirement has become a mainstream idea in recent years. Often referred to as the FIRE (Financial Independence Retire Early) movement, some individuals are saving 50% to 75% of their annual incomes with plans to retire in their 40s or 50s (some bold early retirees aim for their 30s), well before the traditional retirement age of 65. In order to fund these early retirements, adherents typically save 25 times what they expect to spend per year in retirement, then withdraw 4% per year. In theory, based on the historical market performance of the S&P 500, early retirees can safely withdraw 4% from their investment portfolios and live off the investment returns, adjusted for inflation, for decades with a high probability of never running out of money.
A common thread among aspiring early retirees is a desire to help their communities after leaving the workforce, with philanthropy a high priority for many. However, because early retirees will have different financial circumstances than the typical retiree, there are some things they might want to consider.
Recognize Nonprofit Board Membership Expectations
Early retirees almost never spend the rest of their lives on a beach enjoying umbrella drinks. They are highly successful people who have typically amassed a seven-figure net worth by midlife. Because they want to keep busy and have some connection to an organization, they often conclude that serving on a nonprofit board would be a worthwhile part of their plans. This is noble, but people should keep in mind the financial expectations of being on a nonprofit board. 46 percent of nonprofit boards have 100 percent giving participation, and nationally boards average 74 percent participation.
Unless you have a sought-after skill to offer, you should expect to budget annual gifts for any nonprofit when serving on a board of directors. The expected annual gift for board members varies widely based on organization, with smaller nonprofits expecting hundreds of dollars and some larger nonprofits anticipating thousands.
Don’t Believe You Will Start Giving In Retirement If You Didn’t Give Before
This one is true for anyone, regardless of retirement age. Many people tell themselves that they will give back once their net worth hits a certain point, once they celebrate a certain birthday, or when they retire. The reality is, people are unlikely to start being philanthropic after those milestones if they had no history of giving before. And, alarmingly, young Americans are losing the habit of giving.
People planning for an early retirement should make it a priority to give to their favorite nonprofits before leaving the workforce. There is no need to donate massive amounts of money that will interfere with one’s financial goals, but forming a habit of giving—even small amounts—will prepare one for being a philanthropist in retirement.
Donor-Advised Funds Might Not Be as Beneficial as You Think
People planning for early retirement are generally very well informed when it comes to tax advantaged savings vehicles. They often cite the annual maximum contribution limits for 401(k) plans, IRAs, and HSAs, and many max out all three. It would be fair to say that people on the early retirement track know the tax code and the rules of the game, and plan for early retirement with precision and strategy to limit tax liabilities.
Because of this mindset, aspiring early retirees might be interested in donor-advised funds (DAFs) that allow donors to hold money in investment accounts that are earmarked for future philanthropy. Yet, there are some limitations when it comes to DAFs. You can take an immediate tax deduction when you make a contribution to your DAF, reducing your tax liability in that tax year. However, this deduction is only available to taxpayers who itemize, which is currently only about one in ten taxpayers. Because of this, some people might consider “bunching” their DAF contributions by making a large contribution in one year and filing an itemized tax return for just that year if they typically claim the standard deduction.
Another issue with DAFs is the proposed legislation over the years that could at some point make them much more complicated. As of now, DAFs allow one to save large amounts of money with no firm payout rules. This could change in the future, limiting the ability to harness the power of compound returns through investments. Finally, it should always be noted that money placed in DAFs must eventually be paid to a 501(c)(3) nonprofit organization. You cannot claim your money back from the DAF, not even with penalties.
Remember to Make a Will and Keep Account Beneficiary Information Updated
It is no secret that a large share of philanthropy comes from wills and estates. Incorporating charitable giving into one’s financial goals earlier in life builds a foundation for effective philanthropy that can far exceed what some might expect they can give. This is especially applicable to early retirees who might see decades of compound returns in their investment portfolios.
The most obvious task when it comes to legacy giving is having a legal will created that outlines how much of your estate will go to which charities. It is easier than ever to create a will, with some nonprofits themselves offering services and templates that are legally recognizable. In addition to creating a will, one can often name a nonprofit organization as the beneficiary or partial beneficiary of investment accounts such as 401(k) plans.
Additionally, people should explore more complex giving structures such as Charitable Remainder Trusts, which are irrevocable trusts that let you donate assets to charity and draw annual income for life or for a specific time period.
Required Minimum Distributions Will Likely Play a Major Role in Your Giving
Although someone planning early retirement might not be thinking much about Required Minimum Distributions (RMDs) while on their financial independence journey, RMDs will likely influence their financial decisions and philanthropy later in life. RMDs are money that the IRS requires you to withdraw each year from your tax-deferred retirement accounts, such as traditional IRAs or 401(k)s, once you reach age 72 (73 if you turn 72 in or after 2023). RMD amounts are calculated based on life expectancy and account balances. While the age required to withdraw RMDs may increase over time, they will likely always be a factor when it comes to finances for those in their 70s. Some might consider withdrawing more money in the years before RMDs will be required.
Another tax strategy is to donate assets in one’s investment portfolio to minimize tax liability. Such a strategy could likely help early retirees who might find themselves with large investment portfolios in their 70s and beyond. It is not uncommon to hear about early retirees whose investments far outpace their projected growth since many are conservative with their estimates. Many early retirees end up choosing to work part time or form their own business after leaving their traditional jobs. Take, for example, one financial-independence-oriented couple who left their full-time jobs after years of saving. Now in their 50s, this couple’s investments have grown to $4.3 million. For people with this type of wealth, a strategy regarding RMDs and charitable giving could result in massive tax savings and a lot of worthy donations
The ideas of financial independence and early retirement have earned a lot of public attention in recent years. This is at least partially attributable to a booming stock market over the past ten years that has inflated the investment portfolios of hopeful early retirees. Whether or not financial independence remains a growing trend and ideal for younger workers may depend on continued gains in the stock market, as well as access to jobs that pay salaries high enough to allow people to save at high rates. Regardless, it seems that the concept of early retirement is not going away anytime soon. It is difficult to say what that means for philanthropy in America, but it will be interesting to compare generosity among retirees based on age at some point in the future. Whether someone intends to leave the workforce at 40 or 80, planning and knowledge can help them be a more effective donor.