How to fully utilize a Donor-Advised Fund

An incredibly useful planning tool for charitable gifting is a Donor-Advised Fund (DAF).  A DAF allows you to set aside funds for future charitable gifts while receiving a tax deduction now.

Donor-Advised Funds are especially useful for charitably inclined individuals in the following scenarios:

• An unusually high income year (for example, the sale of a business, exercise of stock options, large bonus, selling appreciated assets, etc.)
• When you’re on the edge of itemizing your deductions vs. taking the standard tax deduction
• If you have highly appreciated stock and want to “reset” your cost basis

Let’s break down each of these options to see the potential benefits.

• In an unusually high income year
  • Let’s say you purchased $100,000 of Tesla stock 5 years ago for $38 per share. Your 2,631 shares are now worth just shy of $2 million (at the time of writing) and you’re ready to diversify your risk, wanting to sell about half of your position.  In this scenario, selling half of your shares would generate a taxable gain of roughly $940,000, almost certainly pushing your federal long-term capital gains to be taxed at 23.8%.  Ignoring state income tax, that means any shares of Tesla you contribute directly to the DAF will save 23.8% just from not selling it. Plus, you get the tax deduction of gifting the stock to the DAF.  If you’re already in the top federal tax bracket, that should save you at least another 30%, depending on the nature of your other income and any deduction limitations.  For a typical couple with mostly wage income, the total savings from this strategy would be over 54% plus any applicable state income tax savings, making our hypothetical $50,000 gift only cost about $23,000.  Now that’s good tax planning!

• When you’re on the edge of itemizing your deductions vs. taking the standard tax deduction
  • Let’s say you’re married and in 2021 your total standard deductions add up to only $25,000, with $5,000 of those coming from charitable contributions. With the current standard deduction at $25,100 for a couple, you get no tax benefit from those $5,000 of donations (unless there is an opportunity to force itemization to save state income taxes, but that’s a topic for another day).  Instead, suppose you practice what sometimes is called “charitable lumping.”  If you are willing to fund the next few years of charitable gifts now by funding $15,000 to a donor-advised fund, all of the sudden you get almost $10,000 of actual tax benefit in 2021, plus you don’t lose any tax benefits over the next few years since you were already taking the standard deduction.  If your effective federal tax rate is 35%, this will save you about $3,500, plus any potential state income tax benefits and/or tax benefits from gifting appreciated stock if you choose to fund the DAF that way.

• If you have highly appreciated stock and want to “reset” your cost basis
  • In our last scenario, let’s say you have a well-diversified investment strategy and don’t want to make any changes. (Congratulations, by the way!)  But some of your stock holdings have appreciated substantially since you purchased them.  Instead of giving cash to charity, consider gifting appreciated stock either directly to charity or to a donor-advised fund and using your excess cash to repurchase the donated shares at a higher price.  That way when you go to sell that stock position in the future, your cost basis will be higher and therefore your tax liability will be lower at the time of sale.  The charity still gets the same donation and you get to reduce both your current and future tax liability.  It’s a win-win-win.

How do you contribute to a Donor-Advised Fund?  All it takes is four easy steps.

1. Open a DAF. All of the major custodians have one (Vanguard, Schwab, Fidelity), so pick your favorite.  Note that Vanguard currently has a $25,000 minimum to open a new account with minimum grants of $500, while Schwab and Fidelity have no minimum to open with minimum grants of only $50.  Be sure to name contingent owners in case something happens to you before you have distributed all of the account balance.  It’s also wise to make sure the charities you wish to support are approved under your ideal custodian before opening an account.

2. Make an initial gift. This can be cash, publicly traded stocks, mutual funds, ETFs, bonds, some private / restricted stock, cryptocurrency, real estate, and other assets.  Ideally, assets you donate to a DAF will be highly appreciated to get the full tax benefits.  Also note you cannot make a qualified charitable distribution (QCD) directly from your IRA to a DAF under current law.

3. Choose your investment options. Just like any other investment account, you will likely have a wide variety of options to choose from (depending on the custodian) to have your funds invested as you deem appropriate.

4. Make donations as you see fit. Under current law there is no annual amount you must gift to charity, so you can choose which charities receive gifts under any time frame you choose.  Just be sure they’re a 501(c)(3) public charity or else the custodian will not be able to make the gift to the charity of your choice.

It’s important to note that donating appreciated non-cash assets to a donor-advised fund is limited to 30% of your adjusted gross income (AGI), with unused donation amounts able to carryover for up to five years.  And the appropriate charitable gifting strategy should be made when looking at your overall financial picture, as other options such as qualified charitable distributions (QCDs) from your IRAs should be considered if you are over age 70.5.

Don’t want to do it all yourself?  Feel free to reach out to see how we can help.