Matt Blocki and Jamison Smith discuss donor-advised funds (DAFs) and their tax benefits. DAFs are investment accounts for charitable giving, offering tax deductions, tax-free growth, and a way to donate appreciated assets. They emphasize the advantages of lump-sum contributions to maximize tax savings and provide an example showing significant benefits compared to annual cash donations.
Matt Blocki with EWA. Jamison Smith with EWA. Today we are discussing for those that are charitably inclined, how a donor advised fund works and how we can use a normally scheduled distribution system that your charity is used to but also receive the greatest amount of tax benefits while doing so.
So, Jameson, give us a high level overview of how a donor advised fund works and what are some of the main benefits why someone would want to set up a donor advised fund. So, a donor advised fund is an investment account where the end goal is ultimately to get the money to the charity.
You can take advantage of compounding interest. So money that’s donated into it, you get a tax deduction, which Matt’s going to go over a specific example here in a second. But take the deduction on the amount that you put in that year.
You can use compounding interest, the money is invested, all the growth is tax free. And then whatever it’s given to the charity, it’s also a tax free event. So, benefits of this, which again, Matt’s going to go over, you can batch all of this into one year to get a bigger deduction and then donate it throughout the course of your lifetime or even after.
So, Jameson, tell us, if I make a big contribution into a donor advised fund, can I decide later that I want to get that money back? No. So once the money is in the donor advised fund, it has to go to charity.
You can’t pull it back out once it’s in there. So, I’ve always heard with a donor advised fund, it involves a double tax break. Give us a high level overview of what is meant by a double tax break. Yeah, so like I said, when you donate the money into the donor advised fund, you get a tax deduction.
We’ve also done this with clients that have a large position in an appreciated stock. So, example, stock has $100,000 of unrealized gains. If you were to sell it, you pay capital gains taxes on that.
Rather, you can donate that stock to the donor advice fund, take the deduction, also avoid the capital gains tax. The charity doesn’t have to pay the capital gains tax and you also don’t have to pay it.
So that would be a double tax benefit. That’s awesome. So, from a ease of setting up, are there any extra fees to have a donor advised fund specifically on the platform that we operate on at Fidelity?
No. Fidelity offers the ability to do this. No extra fees. You would see it right when you log into your Fidelity account, would be just like any other investment account. Jameson give us some examples.
What entities can you gift from a donor advised fund to? And then are there any entities that you cannot gift to from a donor advised fund? Yeah, so, any 501, which most charities would qualify for can receive this.
What can’t is any private foundation or political group. Jameson tell us. If I have made a large contribution to a donor advised fund and then I god forbid I pass, what happens to that money? Yeah, it can be a really useful estate planning tool, especially if you’re charitably inclined.
That money stays in the donor advised fund. It’s actually out of your estate, which is a tax benefit. Then a successor would get appointed to it that would determine when it goes to charity, and you can put any request in your will on how much and what groups that you would want it donated to.
So, Jameson, some of the questions we receive from clients are the differences between what’s the difference between a donor advice fund and a private foundation? Yeah, great question. So, a donor advice fund is essentially a lot simpler.
A private foundation has its own tax filing requirements. It’s its own separate legal entity. There’s a lot more restrictions on when you can and how much you can donate. So, essentially, donor advised fund is just a lot simpler to set up and easier.
Jameson, thank you so much for sharing the details around a donor advised fund. We specifically look forward to answering the questions you have. And for those of you that are charitably inclined either during your lifetime or potentially during your estate planning.
A donor advice fund may be a useful tool that fits into your financial plan. We really look forward to evaluating this with you alongside the rest of your planning. Jameson, thank you so much for going over the benefits of a donor advised fund.
Next, we wanted to provide a specific example of how a donor advised fund could benefit you specifically from a tax perspective, without disrupting the charities receiving what they’re used to receiving from you on month to month or year to year basis.
Common misconception is if you do this, the charity is not going to receive the distributions because you fund it once every five or once every ten years. The charity won’t receive that until once every ten years.
Once you put in this lump sum, the charity can receive it on the same schedule that you are currently doing your cash gifts. So we’re going to break this down here and how this can benefit and put more money into your pocket, or this could put more money into the charity’s pocket if you decide to take the tax savings and actually give it to the charity.
So, first, quick review. We have three examples. First example is just a review of the current tax code. So you either get to choose to take a standard deduction, which, if you’re married filing jointly is 25,100 for 2021.
For the sake of ease of explaining this, we just chose to say 25,000, or you get to decide itemizing your taxes. So just as an example, for someone that has state and local taxes, which are capped at 10,000, and then let’s say you have interest on your mortgage, which is currently capped up to a $750,000 mortgage, if you purchase your house recently, the total there would be $20,000.
So we have the decision if we want to take a $20,000 write off or $25,000 write off. Very simple decision. You’d want to take the $25,000 write off. So this would do us essentially no good. So we would not be itemizing in this example.
We’d be simply taking the standard deduction, scenario two. So scenario two is the same standard deduction for a married filing jointly couple. Um. This. However, state and local taxes are capped at ten.
Interest on the mortgage we’re assuming is also ten. And then our charitable contributions from cash or cash flow is ten. So our total itemized deductions are now 30. So do we choose the 25 or 30? Well, obviously we want to choose the higher amount.
The standard deduction is going to do us no good. We’re going to choose the 30,000. That 30,000 thousand is going to be our write off. But that 25,000. Again, that was our freebie. So there’s only a $5,000 difference from a write off perspective.
So despite the fact that we gave $10,000 away to charity, only half of that, in this case, 5000 of that is actually going to do you good from a tax perspective. So let’s just fast forward this over ten years.
Let’s say we do this every single year for ten years. So ten years times the actual 5000 above, which gets a write off, is a $50,000 write off over the ten years. Assuming you’re in a 35% marginal federal tax bracket, that would work out to be a $17,500 tax savings a little bit each year over the ten years.
The total of $17,500 is what you would assume to save scenario three. So scenario three is no different from the fact that we’re still the end goal is to give the $10,000 per year to charity and let the charity receive that on the schedule that you’re there used to.
As Jameson described, you can gift appreciated stock into a donor advised fund, which is limited to 30% of your adjusted gross income. So if your adjusted gross income is 501 lump sum, you could take 150,000 of a stock and gift it in there.
In this example, we’re going to use the same 10,000 a year times ten years. So that’s 100,000. We’re going to assume that you have a $100,000 of stock and we’re going to gift that all in one year to the donor advice fund.
So, same example, state and local taxes, ten interest, ten. We’re putting 100,000 into that donor advised fund. We refer to that as the Daft. The DAF. So now we have $120,000 write off. That is $95,000 over the standard deduction.
So obviously we’re not using the standard deduction. That $95,000 above is our actual tax benefit for doing this planning at a 35% marginal bracket, we’re now getting 33,250 in tax savings above and beyond that.
And the main reason for that, instead of only getting half of the charitable contribution as a write off in scenario two, we’re now getting all but 5000 of that hundred is entirely a write off. So immediately, almost two X the write off right off the get go.
Because we batched it one year instead of over ten years, DAPs provide a double tax benefit. However, because we chose a stock in this case, we’re assuming that you had a stock that had done very well and you’ve probably held it for a long period of time.
So let’s say you have a basis of 10,000. You’ve let that ride. And if you sold this stock on your own balance sheet for your own use, you’d have to pay a capital gain tax. Assuming you’re in that marginal rate, you’d be in the highest capital gain rate, 23.8%.
That tax, if you sold it yourself, would be 21,240. By allowing the stock to be the gift to the DAF, we avoid that capital gain tax altogether. And the charity being a 501, being a charity avoids that capital gain tax as well.
So not only do we have the 33,250 federal tax write off, we also have the $21,240 capital gain avoidance. So all in all, we’ve now saved a total of 54,670. And the difference between option two, which was 17,500 and option two.
Which was over $54,000. That’s a $37,000 difference just by deciding to lump sum the money in the Daft from an appreciated stock. So in reality, what this would look like if you have a non qualified or brokerage account, we chose the lowest basis stock.
We’d gift it to the DAFF. You’d turn off your charitable contributions on a monthly or annual basis to the charity itself and instead you would re invest that in your own account, which would then come with a higher basis and make you more tax efficient down the road.
And then the donor advised fund, once it’s in there, that money gets invested and it compounds or using compounding interest for the benefit of the charity. That now fulfills on a monthly, annual, every other year, whatever schedule you want.
That DAF now writes the check to the charity in the same schedule that the charity is used to. So we highly recommend, if you have a consistent charitable intent in mind, to utilize a donor advised fund.
Given the current tax climate and the use of batching, the standard deduction. In this example, this person would itemize one year and then use the freebie the next nine years, which would end up in the $37,000 of taxes saved.
We welcome any questions and look forward implementing this for those that are charitably inclined.