By Janelle Fumerola, CFP®, MBA – Regional Managing Director
& Beth Williams, CAP® – Client Advisor
Charitable giving can be a key component of an overall wealth management strategy for affluent individuals and families. Creating a comprehensive charitable giving strategy may help you donate cash and other assets to the non-profits you want to support in the most efficient and tax-wise manner.
One of the best tools for charitable giving is a special tool known as a donor advised fund (DAF). You could realize a number of financial and tax benefits by using a DAF to make charitable contributions.
How DAFs Work
A DAF is a pool of money managed by a non-profit organization on behalf of donors. When you make contributions to a DAF, you can decide which charities will receive assets from your portion of the fund, as well as when they will receive the assets and how your contributions will be invested. The non-profit organization takes care of fund setup in exchange for an annual administrative fee that’s paid by donors.
You will receive a deduction for charitable donations to a DAF during the year when you make them — then you can decide later which specific charity or charities will receive your grants. You can even pool the resources of family members and friends to donate to a DAF together if you want. This makes DAFs a great tool for establishing an enduring family legacy of philanthropy.
Effective DAF Strategies
One effective DAF strategy is to “bunch” several years’ worth of charitable contributions into a single year so your total contribution exceeds the standard deduction ($25,100 for married couples filing jointly in 2021). This will enable you to receive the maximum deduction for your DAF contribution during the year in which it is made.
Anther strategy is to donate appreciated assets to a DAF instead of cash. This way, you won’t have to pay capital gains tax on the asset’s appreciation while the charity will receive the equivalent of the asset’s full current value. You’ll also be able to donate (and deduct) more than you originally paid for the asset. Investment securities (like common stock) and real estate are often donated to charities in this way.
For example, suppose you bought stock in a company 10 years ago for $5,000 and it’s now worth $20,000. If you sold the stock and donated the proceeds to charity, you’d pay $3,000 in capital gains tax (at the top 20% capital gains rate), leaving $17,000 for the charity. But if you transferred the stock directly to the charity, no tax would be owed and the charity would receive the full $20,000. And your out-of-pocket cost of the donation would be what you paid for the stock 10 years ago: $5,000.
Yet another strategy is to make a charitable contribution to a DAF during a year when you’re doing a Roth IRA conversion. The money that’s converted from a traditional IRA to a Roth IRA is taxed at ordinary income tax rates during the year of the conversion, which can result in a hefty tax bill. The DAF contribution will lower your adjusted gross income for the year, which could help lower your income taxes.
An Illustrative Example
The following hypothetical example helps illustrate how a charitably minded individual could lower his taxes by making charitable contributions to a donor advised fund.
Dave sold his closely held consulting business this year for $1 million. With the top marginal income tax bracket currently at 37%, Dave will owe $370,000 in federal income tax on the sale. But he decided to fund a DAF with a $100,000 contribution, which will lower his income on the business sale to $900,000 and his tax bill to $333,000, a tax savings of $37,000, which is greater than the standard deduction of $25,100.
In addition, Dave decided to donate some appreciated stock he owned to make the DAF contribution instead of donating the proceeds from the business sale. This saved Dave another $20,000 in capital gains taxes.
To Learn More
Please contact your CooksonPeirce advisor if you have more questions about donor advised funds. We can help you determine if this might be a smart charitable giving strategy for you and your family.
Materials discussed is meant for informational purposes only, and it is not to be construed as investment, tax or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.