When should retirees consider a donor advised fund?

Too often we think of charitable giving in the context of the rich and powerful, where, it seems, the rich continue to get richer through a complex charitable strategy. Although well-structured charitable donations have significant tax advantages, the reality is much less exciting. You’ll save a certain percentage of your donation if you do it right, but you’ll still end up with less money than you started with. That’s the point: you’re giving money.

When it comes to charitable planning, charitable intent should be the first box to check. Once you have decided that you can afford to give and that you want to give, you need to decide how you will give. A donor advised fund (DAF) could be that “how.” Simply put, a DAF is a financial account that allows you to make contributions of cash or tax-deductible assets, invest the money in the account tax-free, and then recommend grants from the account to your favorite charities over time. The tax deduction is recognized at the time you contribute the money to the DAF, regardless of when the money reaches your charity of choice.

Below are four triggers you can use as a hand raise exercise. If you are charitable and have raised your hand on one or more of these triggers, you should evaluate a DAF. I have also used this strategy for many clients who are not in these situations, so this list is by no means exhaustive.

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1. You have just retired or sold your business.

The typical tax trend for those retiring is down, then up. Once wages are gone, but before you claim Social Security and take distributions from retirement accounts, your effective tax rate should be lower. Charitable contributions will have less impact because they compensate for a lesser obligation. On the other hand, your final year of work is often the year with the highest income and, therefore, the highest tax rate. If you own a business and have just sold it, the situation is made worse.

A DAF will allow you to make significant charitable contributions during that final working year and take that deduction against a larger amount of gross income, without having to decide who you give to. You can make this decision in subsequent years when grants are made from the fund to the charities of your choice.

2. You’ve sold your “forever home.”

We are in the DC metro area. It seems that in the last five years, every home purchased by a baby boomer in the 80s or 90s is now worth over a million dollars. This is a problem as an owner, but it likely makes some of the gain taxable from the IRS perspective. Depending on the size of the gain and where you live, it can be substantial. A $500,000 gain in Maryland will likely cost you $150,000 in federal and state taxes.

Just like your final year of work, charitable giving has a greater impact in years when your tax rates are particularly high. Since this is a one-time success, your rates will drop again next year. We often advise our clients to make several years of charitable donations during the year of sale and distribute those funds in subsequent years as you would under normal circumstances.

3. You want to diversify your investments from a concentrated investment.

My sister works for Amazon. Like many tech companies, Amazon offers stock compensation to help attract top talent. While this is one of the best ways for my sister to build wealth over time, it creates risks in retirement. A concentrated position is generally considered a stock that represents more than 10% of your overall portfolio. For example, let’s say my sister retired with a portfolio worth $3 million and her Amazon stock was worth $500,000. This would be a concentrated position.

A DAF would allow him to place shares, $200,000 in this case, of those shares in the fund. This would serve two purposes: It would give her a Schedule A deduction of $200,000 and allow her to avoid the capital gains tax she would have owed if she had sold the shares.

4. You no longer detail.

In 2018, the Tax Cuts and Jobs Act (TCJA) significantly changed the tax code. The Tax Foundation estimates that only a third of taxpayers who itemized before the TCJA do so after the TCJA. Simply put, a very small percentage of taxpayers will actually be able to take a charitable deduction for their donations, because they don’t give more than the standard deduction.

This reality has introduced a strategy called “charity stacking,” where instead of giving every year, you give multiple years at once. For example, instead of giving $10,000 a year for five years, you give $50,000 in one year and then don’t give again for the next four years. This allows you to exceed the standard deduction in the first year and receive a tax benefit for your donation.

The advantage of the DAF in this scenario is that it does not have to disrupt the beneficiaries of your donation. You can donate to the DAF in the first year and then make grants from that fund in subsequent years, just as you would if the funds came from your bank account.

Key questions before donating

When considering making a charitable donation, ask yourself these three questions in this order:

Are charitable donations the main intention?
Can I afford to donate?
How should I give?

This article is about the last question.

Your financial plan should tell you if you can afford to give. If you would like to try a free version of the financial planning software we use, you can access it here.

This article was written and presents the views of our contributing advisor, not of the Kiplinger editorial staff. You can check the advisors’ files with the SECOND or with FINRA.