How to use a Donor Advised Fund to be Generous & Tax Efficient

Michael QuanGiving, How to, Misc, Saving Money, Taxes2 Comments

Some links below may be from sponsors. Please see our disclosure for more info.

Donor-Advised-Fund-DAF

I first read about the Donor Advised Fund (aka. DAF) from Physician on FIRE (PoF) a few years ago. However, I didn’t pay much attention back then as I was content with our giving plan and thought this type of contribution was beyond our budget at the time.

The Relationship Between Taxes & Giving

Let’s fast forward to 2020. A lot has happened. In the midst of the global pandemic, I decided to sell our San Diego rental property. You see there was a ton of equity inside of it (it was our prior home), but the rent we were collecting wasn’t producing a good enough return for the amount of equity contained inside. I ended up selling the property myself (FSBO) and ultimately decided to NOT do a 1031 exchange. (If you’re curious why, you can read more about it here.)

Because of the sale, we have a six-figure gain and depreciation recapture taxes to deal with. After working with our CPA, she showed us a tax bill projection of $30k more than the prior year… ouch. Nevertheless, I socked that away and was ready to simply hand it over to the IRS this coming April.

Becoming Tax Efficient

I didn’t think much more about it until Cyber Monday week. You see, right around the same time, there’s another special day called “Giving Tuesday” that celebrates charitable donations and the act of giving (definitely needed this year!). Right around this time, our wealth advisor asked if we had any gifts we wanted to make before the year’s end. As a way to be tax-efficient, they suggested we consider giving away some appreciated equities to charities of our choice. We’ve actually done this before and the nice thing is you’re able to donate the full market value of appreciated stock without having to pay capital gains taxes at all.

And this is what triggered me to go back to PoF’s article that was still in the back of my mind. Maybe we could use a DAF to offset that additional $30k in taxes we’re looking at in 2020? Maybe a DAF could simplify our giving for years to come?

After additional research and passing the idea by our wealth manager, my wife and I both agreed it was worth looking into further. So we got our CPA involved to run some projections for us. She was great and illustrated a few different scenarios to maximize our gifting this year, as well as a couple of partial scenarios.

Tax Benefit Limitations

I should note that there are some limitation CAPs on how much you can donate in a given year, even if you’re using a DAF. As it stands now, donors can receive a tax deduction of up to 30% of AGI (adjusted gross income). This can be in the form of appreciated securities, mutual funds, real estate, or other assets. In our case, our CPA illustrated a scenario where we could eliminate $28,000 of our additional $30,000 tax bill this year… WOW! This will require us to “bunch” up our donations all at once to maximize our deduction. And, it makes a ton of sense to do that this year. *Side note: if you decide to give more than your maximum allowed deduction, you can carry over the adjustment 5 years into the future for future tax savings.

Starting Up Our DAF Plan

So, our plan is to donate $85,000 into a donor advised fund for the 2020 year. While this may seem like a lot of money at first glance, earmarking this money for charity doesn’t mean you have to give it all away at once. Rather, a lot of people use the DAF as a place to grow the money tax-free. That also means any future appreciation of the DAF is not subject to capital gains tax or otherwise. That means more potential money to give away in the future!

Now once this money has gone into the DAF, it’s technically no longer yours. However, you do have the ability to make recommendations to the administrator of where you’d like to see the funds go to. There are many different administrators who can help you set this up. Some of the more well-known ones are Fidelity Charitable, Schwab Charitable, or even Vanguard.

For us, we decided to go with our wealth manager’s partner, Greater Horizon. We liked that they had no minimum donation recommendation meaning that I can ask them to donate as little money as I wish so long as it’s a reputable non-profit organization. Fidelity Charitable and Schwab Charitable have a minimum give recommendation of $50. Vanguard Charitable has a minimum that’s 10X the amount at $500, however, their fees are less so you’ll want to consider the tradeoffs for yourself.

Set up was a cinch and I was able to complete the paperwork within 30 mins or less. Once established, most DAF administrators will set you up on their portal for you to view and manage your Donor Advised Fund. Here you’ll be able to manage asset allocation and also make grant recommendations (giving instructions).

Fees to Consider with a Donor Advised Fund

There are some fees to consider. Most administrating companies charge a minimum fee of $150+, and/or a percentage of the overall portfolio value they are holding for you. If you have a wealth manager who partners with them, it’s possible to have them manage it for you and extend your fees across, or you can keep things simple and throw it into a broad-based index fund and let it ride. The managed option will likely cost a full point. So you want to ensure the costs are in line with your giving schedule and outlook.

Here’s a sample fee chart from Schwab Charitable.

More DAF Benefits

Because we pulled out a chunk of cash from the sale of our property, we’ve had another quality problem… what should I do with the cash? After paying down some other rental property mortgages, we were still left with a chunk of cash lying around. The DAF actually helps us with this problem too! As I mentioned earlier, the DAF can receive appreciated stock from a non-qualified account.

Since I have some stocks that I purchased back in my 20’s, there is a handful with significant gains inside that portfolio. Let’s take GOOG for example. I purchased shares back in 2004 just after their IPO. It’s since appreciated with a 1000%+ gain. If I give that stock to the DAF, then I owe NO capital gains on that transfer. However, let’s say I still want to hold that stock in my portfolio. Once I transfer into my DAF, I can simply buy back the shares with free cash at the current day price. This allows me to remain “invested” in the same position but with a stepped-up basis now (i.e. I’m no longer exposed to the 1000% gain if I decided to sell it later).

Other DAF Considerations

A Donor Advised Fund is great, but here are a few cons/considerations:

  • Once you give away the money, it’s no longer yours
  • There are additional administrative and management fees you’ll need to pay
  • It can delay your giving from the present into the future – you’ll have to balance this and ensure your recommendations are being made regularly, otherwise, why have the DAF?
  • Certain funds have a minimum grant amount

Conclusion

That said, I personally believe the advantages far outweigh the benefits. A Donor Advised Fund can be an incredible way to be generous now and into the future while providing you with some nice tax benefits upfront.

Readers, what do you think? Is a Donor Advised Fund a good idea? Would you consider it?

Follow me

2 Comments on “How to use a Donor Advised Fund to be Generous & Tax Efficient”

  1. Taxes… Lowering them is a very complicated process but it should be learned in every person’s personal finance journey. Glad to be reading personal finance blogs to make sense of them at least in one area.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.