Saving Money on Charitable Giving - A Brief Introduction to Donor-Advised Funds
Welcome to Saving Money with Andrew!
A few respondents to my anonymous reader poll (still open, still anonymous!) asked for more sophisticated posts on money-saving topics. Here’s a more advanced look at charitable giving strategies for those readers fortunate and generous enough to be able to make meaningful charitable donations.
In Wealthy Use Loophole to Reap Tax Breaks — And Delay Giving Away Money (free registration required to read the full article), Bloomberg News discussed strategies that the wealthy use to donate to charities for pennies on the dollar.
[Elon] Musk faced what he claimed would be the biggest tax bill in US history after exercising millions of options on Tesla shares. In November, filings show the world’s richest person gave $5.7 billion of the electric-car maker’s stock to charity. With the top federal tax rate at 37%, the gift could cut Musk’s 2021 federal tax bill by as much as 37¢ for every dollar given away. By contributing shares, rather than selling the stock for cash, he could also avoid taxes on capital gains, saving an additional 20¢. Minimizing the US estate tax, a 40% levy on large fortunes at death, brings his total theoretical savings to 74% of his gift.
What’s the strategy these wealthy individuals use to make charitable donations? It’s actually pretty simple—the donor-advised fund (a DAF).
What is a DAF? A DAF is simply an account that allows the holder to make grants to charities. The holder deposits money or other assets (most commonly investments) into the account, can take a charitable deduction upfront, and can then make grants to charities over time.
The three largest and best-known DAF providers—Vanguard Charitable, Fidelity Charitable, and Schwab Charitable—have tens of billions of dollars in assets across tens of thousands of accounts.
So, how can you use a DAF?
First, create an account with one of the major DAF providers.
Next, fund your account with an initial contribution of cash or investments (so you can take an immediate deduction). Fidelity and Schwab don’t have a minimum deposit, though in practice it likely only makes sense to open a DAF account if you are making significant donations.
Finally, make grants over time to your preferred charities.
What are the benefits? The most obvious benefit of a DAF is being able to take a deduction immediately, while making your actual donations to charities years into the future. If you typically take the standard deduction, you generally receive no benefit for your charitable donations. But, if you front-load all of your giving to a DAF in year 1, you may have enough in deductions to make itemizing worthwhile.
But the greatest benefit of a DAF (which is what Elon Musk did) is to fund it with appreciated stock. If you own publicly-traded stock that you have held for more than one year and is worth more than you paid, contributing it to a DAF allows you to deduct the current value of the stock, while never paying tax on the appreciation of the stock. The net result is to allow you to make charitable donations for pennies on the dollar. A simple example (which assumes you itemize your deductions):
Assume you own $20,000 worth of stock that you paid $4,000 for many years ago. And assume you are in the 35% federal income tax bracket in a state with 5% state income tax, for a total marginal tax rate of 40%.
If you donate the stock to a DAF, you will receive a tax deduction worth $8,000, while also never having to pay $4,600 of tax (on your $16,000 of gain).[1]
Effectively, you are able to fund $20,000 worth of charitable giving for only a net cost of $7,400, or about 37 cents on the dollar.[2]
What are the catches? There are a couple:
The major DAF providers charge fees slightly higher than simply having your money in a basic index fund or ETF. But they are not that much higher, and in some cases (e.g., if you work for a large employer that has negotiated a discount) there may be discount rates.
There are some additional restrictions on donations made from DAFs. Most notably, you typically may not use DAF funds to purchase tickets for charitable events (or to receive other items of value), or to fulfill charitable pledges (among other restrictions).
But, overall, DAFs are a terrific way to streamline your charitable giving and maximize your tax benefits.
Finally, note that this post is not tax or investment advice. As always, consult your accountant or financial adviser when making a big decision like this.
And now, Andrew’s pick(s) of the week:
I’ve been enjoying the performances of Sierra Hull, a Grammy-nominated “singer-songwriter, mandolinist, and guitarist”. Here’s a great video of her cover of Del McCoury’s “I Feel The Blues Moving In”:
Also:
I have never heard of Rod McKuen, who sold over 100 million records and was nominated for two Oscars. But if you are over 55, you probably have. Rod McKuen Was the Bestselling Poet in American History. What Happened?
Didn’t Realize Your New Koi Can Live to 80? Call Fish Rescue
It’s Never Too Late to Pivot From N.F.L. Safety to Neurosurgeon
I hope this has been helpful. If you liked it, please share it on social media! Also, please send me your feedback, requests, and success stories.
[1] I’m assuming 23.8% federal tax on the (long-term) gain and 5% state tax.
[2] In states with high tax rates, such as NY, NJ, and CA, the math is even better.