Strategies for Success: How to enhance your tax savings from charitable giving with a Donor-Advised Fund (DAF)
As a follow-up to our recent Tax Smart Investing presentation, we are posting several blogs that explain some of the concepts that we discussed. The presentation was specifically focused on ways to improve your portfolio’s lifetime after tax return.
While we didn’t discuss it during the presentation, another Tax Smart move is enhancing your tax benefits from charitable giving. One way we can help clients enhance their benefits from charitable giving is by using a Donor-Advised Fund (DAF). This blog post focuses on how to use a DAF and the benefits it can provide.
Other Tax Smart blog posts that were developed from our presentation that you may be interested in reading are:
- Strategies for Success: Advisor’s Value
- Strategies for Success: Roth Contributions & Conversions
- Strategies for Success: How Asset Location is Tax Smart
- Strategies for Success: Tax Loss Harvesting
For many of our clients, their financial goals are greater than themselves. Our clients want their financial resources to provide for their lifestyle goals, enhance the lives of their descendants, and improve the world at large through charitable giving. The United States Government wants citizens to be charitably inclined and thus promotes giving by providing tax benefits. The more one uses their charitable giving to reduce their tax burden the more they have to provide for their lifestyle, and descendants and/or give more to charity.
Writing a check to a charity can provide a tax deduction for those that itemize on their tax return. Donating appreciated securities directly to a charity can be beneficial when the charity has the capability to receive it and the donation is large enough. A DAF has advantages that in the right circumstances can enhance one’s tax benefits even more.
After selecting a provider and opening a DAF you contribute cash, appreciated assets or investments into your DAF account. Think of your DAF account as a savings/investment account you are earmarking for charity. Realize, once you have contributed to a DAF you can direct a grant, but you can’t get the money back. Once you have funded a DAF it is typically invested with the hopes of growing how much it is able to impact the community. Your DAF may be invested in a pool or you may have options depending on the provider you select .
Over time (or immediately) you recommend grants to qualified U.S. public charities. The charity receives a check from the sponsoring organization and is not impacted any differently than had you written a check.
So, you may be asking what are the benefits that would justify the additional costs and efforts of using a DAF.
1) Let’s imagine I plan to give $500 cash to 6 different organizations. Instead of scratching their checks, I transfer an appreciated ETF valued at $3,000 into my DAF and put the $3,000 cash I would have donated into my portfolio to buy the ETF back. I now own the ETF with a higher cost basis, and I get the same $3,000 deduction on my itemized tax return. The options aren’t any different on my taxes today but when I need the money out of my portfolio in the future, I will have fewer taxes to pay.
2) You can enhance your deductions this year and give it to charity over several years. With a currently higher threshold to itemize many people are using DAFs in a technic called bunching. Bunching is when you contribute appreciated securities valued at multiple years’ worth of your annual charitable giving and then skip personal giving in future years as you provide grants to charity from the original contribution. For many of our clients this allows them to itemize in some years and take the standard deduction in other years thus increasing their tax reduction over the combined time periods.
3) Reduce your risk of a security that has grown to be an outsized portion of your portfolio. It is not uncommon that an onboarding client has a security they received through employment or from when they were younger that has grown to be a much larger portion of the portfolio than is ideal. The growth was of course fortuitous but now that one stock’s fluctuation heavily impacts the client’s net worth and chances of achieving their goals. By donating at least, a portion to their DAF instead of selling it they reduce their risk in that security, reduce the tax hit, and can save more over the coming years to replenish their portfolio instead of giving to charity from their income each year.
4) Additionally, some clients have goals to use some of their income to impact the community today but want to save and grow a portion each year to have a significant one-time impact down the road. By contributing to a DAF each year (or periodically when bunching) but granting less than they contribute, they invest the remainder to grow and someday make the large impactful donation they have dreamed of. If it grows large enough, they can even try to use it as a perpetual fund giving the growth and maintaining the principle contributed.
5) Some use it to set a family legacy behavior of giving. I have seen people go two different directions with this goal. Some tell their children about the fund, why it exists and that they will be named the grantor in the future to continue its impact. Others tell their children they can suggest grants today that “we” will have it distributed.
A DAF isn’t for everyone. Along the spectrum of charitable giving choices, they’re relatively easy and affordable to establish, while still offering some of the benefits of a planned giving vehicle. As such, they fall somewhere between simply writing a check, versus taking on the time, costs and complexities of a charitable remainder trust, charitable lead trust, or private foundation.
To learn more about the costs, investment options, services and expectations of sponsoring organizations don’t forget to read How to pick your Donor-Advised Fund provider.
If you’re working with BCR, we hope you’ll lean on us to help you make a final selection and meld it into your greater personal and financial goals. If you aren’t you can reach out to a sponsoring organization to learn more about how a DAF might impact your specific situation.
Some of the material above was provided by Wendy J. Cook Communications, LLC