When a household cleaner promises “triple-action power,” it’s wise to read the fine print. In wealth planning, too, that can be a tall order to fill. But if you are charitably inclined, it’s worth being aware of three ways in which a donor-advised fund might be worth considering as a potent addition to your wealth strategy:
- Give more – Maximize the value of your gifting for your intended recipients
- Pay less – Minimize or eliminate your capital gains taxes on highly appreciated holdings
- Live Better –Harness the staying-power of a Donor Advised Fund to make philanthropy a meaningful and lasting family activity
Donor-Advised Funds: An Overview
The National Philanthropic Trust offers a succinct description of Donor-Advised Funds (DAFs), comparing them to being “like a charitable savings account.”
- Donate. You make charitable contributions into your DAF account, beginning with as little as $5,000. You can contribute to your DAF once, or repeatedly over time.
- Receive tax benefit. You receive immediate tax benefits for your donations in the year that they’re made.
- Distribute grants. You can take your time recommending when and to which charities the contributions are ultimately distributed.
- Maintain advisory control. As the name implies, you or an investment manager you name can have an advisory say over where your DAF assets are custodied and how they are invested.
- Build a legacy. You can bequeath your DAF to a successor as a lasting, family legacy.
Why Bother with a Donor-Advised Fund?
Why not just write some checks to your favorite charities and be done with it? Sometimes, when life is simple, that’s exactly what we advise. But there are a number of scenarios where a DAF can help you make your good deeds even better.
For example, through hard work, family inheritance or other unexpected windfalls, you may face any or all of these circumstances:
- Wealth tied up in interests that warrant specialized investment- and tax-management planning, such as:
- Highly appreciated, publicly held stocks or mutual funds
- Closely held interests in businesses like C Corporations, S Corporations or LLCs
- Complex life insurance arrangements
- Retirement assets
- Real estate, art collections and similar illiquid assets
- Years when you are facing unusually high taxes, in which offsetting strategies would be particularly useful
- Years in which you would like to make a sizable cash gift, but you are not yet ready to identify particular beneficiaries for the entire amount
In these scenarios (and many others), a DAF can come in handy if you are charitably inclined to begin with.
Case in Point: Diversifying Professionals Risks, Maximizing Charitable Rewards
To offer an illustration that strikes close to home for many of our readers, we often hold Cogent Conversations with successful traders and other high-end professionals who own thousands of shares of highly appreciated company stock.
This is a nice “problem” to have. But it’s still a problem, as it sticks you between a rock and a hard spot when diversifying your personal and professional market risks. Rock: A great deal of your personal wealth is dependent on the ongoing success of your business, with no safety net in place should unforeseen circumstances derail your company’s growth. Hard spot: Selling shares outright, if even possible, would subject you to punishing tax ramifications.
Enter the DAF as your potential lever. Coordinating tax and wealth management, we help families explore whether and when it may be in their best interests to gift some or all of their appreciated stock into a DAF. From there, you can make grant recommendations once or over time to one or many charities to whom you are intent on giving. The donations are meaningful to the charities who receive it; and your personal wealth “eggs” are removed from your career risk basket in a highly tax-efficient manner.
Doing a DAF
Similar logistics apply for any significant collection of highly appreciated securities that would otherwise generate burdensome taxes upon liquidation. If you look ahead several years or possibly to a lifetime of charitable intent, you can pre-fund your giving by using your highest-appreciated securities to establish a DAF today. You can then receive the tax deduction for the charitable gift, avoid paying capital gains taxes when selling or transferring the securities, and generate a sizeable donation for your chosen philanthropic interests.
Calculating the Potential
For example, let’s say you wanted to use the proceeds from a highly appreciated security to give $1,000 to a particular organization, the fictitious GreatCause.org. But what if Great Cause cannot accept the gift as a transfer in kind? Or what if the security is worth more than you want to give to any one organization? You’re faced with liquidating all or part of it to get at your assets.
Of course the following numbers are subject to all sorts of factors specific to your circumstances, but for illustrative purposes, here’s what a calculation might resemble (in this case assuming highest tax brackets for a typical Illinois taxpayer):
Scenario One: Selling appreciated stock for $1,000 cash gift to Great Cause
You Spend ($1,000 donation + $398 capital gains taxes) $1,398
You Receive (charitable deduction) – $484
Your Net Cost for $1,000 Donation $914
Scenario Two: Funding a DAF and recommending a $1,000 cash gift to Great Cause
Your DAF Spends ($1,000 donation + $0 capital gains) $1,000
You Receive (charitable deduction) – $484
Your Net Cost for $1,000 Donation $516
It’s worth noting, because your DAF is itself a 501(c)3 charity, you take your charitable deduction in scenario two in the year that you fund your DAF, irrespective of when funds are actually granted to your recommended charitable beneficiaries. As such, careful tax planning is warranted to make the most of your deduction.
There are a number of other scenarios under which funding a DAF may make sense for your charitable intent, including:
- Building a strong mechanism for ongoing giving while avoiding some of the complexities of establishing a private foundation
- Increasing the flexibility of your grant-making timetable
- Building a multi-generation legacy of giving
- Establishing anonymity between you and your beneficiaries
- Being able to manage the assets to match your giving schedule
To the DAF in action, we recommend this video, “A Smarter Way to Give.” From Fidelity Charitable, a great resource for relevant information. We also want to reemphasize the importance of involving your CPA throughout the planning, to ensure accurate and effective tax management for your circumstances.
A DAF doesn’t make sense for all donors under all circumstances. There are many times the best course of action is the simplest: Write a check to the cause. But we wanted to introduce you to the possibilities here, because the DAF can be a relatively simple, but often overlooked “happy medium” between you, your taxes and your charitable intents.