During the holidays, giving is on the mind. Who should you give charitably to? How much should you give? What is the best way to give?
If you want a tax efficient way to set up long term giving, a Donor Advised Fund (‘DAF’) may be for you.
How do Donor Advised Funds work?
Donor Advised Funds (‘DAFs’) are a way to donate cash, stock, etc now to support charitable causes later. A Donor-Advised Fund is an account that you can make a contribution to and qualify for a tax-deductible charitable donation. Once you contribute the funds, you cannot take money out of the account for non-charitable purposes later.
Donor Advised Funds stay in the account until you are ready to give funds to a qualified public charity (even years later). However, Donor Advised Funds aren’t for everyone.
When should you use a donor-advised fund?
For our tech professional clients, this may look like donating company stock they’ve held for a long time to a Donor Advised Fund. Or setting up a Donor Advised Fund at a company exit to help with long term giving. This sets them up for the tax benefits of a Donor Advised Fund that then grows tax free for supporting future charitable endeavors.
The top reasons to use a Donor Advised Fund are:
- The tax benefits in donating highly-appreciated stock
- The strategy of ‘bunching’ charitable contributions for a tax deduction
- Planning during a company exit (Merger, acquisition, or IPO)
- Investing the funds to grow tax-free for future charitable giving
What are the tax benefits of a Donor Advised Fund?
The tax benefits of a DAF are threefold:
1. You can give cash, stock, or other complex assets (land, etc). You can transfer over low cost basis assets without paying the tax on unrealized capital gains. If you had to sell the stock or asset to make a donation, you’d pay taxes and potentially have less to give in cash. With a stock or asset transfer, you give the fair market value of the contribution without additional tax consequences.
2. You get an immediate year charitable deduction for your contribution to a DAF. This means you can take your higher income years to make a larger DAF contribution that can be used over many years.
3. You have the opportunity to invest the donation in stock investments to grow tax-free until you are ready to give funds to a charity. Since the funds are already in the DAF account, any stock sales won’t count against your personal tax return.
Bunching charitable contributions for a tax deduction
Do you give $10,000 a year towards charities and still take the standard deduction on your tax return? If you are able to contribute more to a DAF every few years, you may be eligible for a bigger tax deduction for the year.
There is no contribution limit on how much you may donate to a Donor Advised Fund..
This can help you plan your charitable contributions a bit more beyond giving to charities through the year. You could decide to contribute two year’s worth of charitable funds to make sure each dollar counts towards a deduction on your tax return.
Matching a high income year with a larger DAF contribution
Another strategy is to make a contribution the same year as your company exit. If you have stock compensation at a smaller tech company and own shares, this may me a good time for a DAF. When income is very high, a charitable contribution to a Donor Advised Fund could set up your giving over the rest of a lifetime. At SeedSafe Financial, we understand your charitable giving goals, any flexibility needed for the funds, and make a discounted cash flow analysis to know what amount may work well for a contribution.
You may reach a level where you are over the threshold for a current year’s itemized deduction on your tax return. Any charitable contribution more than the limit will carry forward for up to 5 years. For 2023, the general limit on charitable contributions to DAFs is 50% of adjusted gross income.
Ease to open, low cost to grow, and streamline your giving
Donor Advised Funds are as quick to open as other brokerage investment accounts. You can be up and running within minutes on sites like Schwab Charitable, Fidelity Charitable, and CharityVest.
You can choose to invest all or part of your funds in the DAF account. Your contribution should be invested based on your charitable giving goals. Are you hoping to use this account primarily for giving in retirement, over your lifespan, or in the next few years? The risk you may be comfortable taking in each of those situations could differ. Growth from investing the funds in the account will be tax-free.
Most Donor Advised Funds offer a low cost mix of ETFs or model portfolios to choose from. This helps streamline your investment strategy while you decide how you want to give the funds over time.
How does it work to send funds to charities from the Donor Advised Fund?
Giving funds to a charity through the Donor Advised Fund is called a ‘grant’. Qualified grants are generally to public 501(c)(3) charities. The IRS has a search tool for you to review what organizations meet this requirement on their website (HERE). The DAF providers may differ in the process of distributions to charities and may have a minimum grant size requirement. When reviewing DAF providers, it is important to know how and when you want to use the funds so you can pick the best option for you.
In the end, a Donor Advised Fund works best for higher-income earners or those with large gains sitting in their taxable investments. How much to contribute is based on what your hopes are for charitable giving. We recommend reviewing this strategy with a tax professional or financial planner. Especially if you are considering donating exercised incentive stock options.
Looking for a financial planner and CPA? Schedule some time with us to chat and learn more about our services.
The above discussion is for informational purposes only. Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.
