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How to Reduce Your Taxes Using a Donor Advised Fund
- By Travis Echols
- •
- 09 Jan, 2020
Flow chart at the end updated for 2021.
Because of tax changes starting in 2018, Donor Advised Funds (DAFs) have become increasingly popular for good reasons. DAFs can save you a bundle in taxes.
To make it simple, here is how a Donor Advised Fund works. A DAF lets you make a charitable donation now, receive the tax deduction for this year, yet the assets donated do not have to be granted to your charities/church until later. You don’t have to decide which charities will receive your gift now, and there is no deadline for you to make that decision.
The money you place in a DAF generally can grow tax-free while you decide over time when and to which charities your contribution will be granted. By the timing of your giving not being tied to the timing of your granting, you have much more control.
A DAF lets you seize tax-saving opportunities through
charitable giving while deferring the decision of who
gets the money. You are still in control of when the charities receive their grant. Let me be quick to say that there is no strategy that I know of that increases your net worth by spending or giving away more of your money. The financial benefit I am talking about here is HOW to give what you would normally give anyway. The DAF is a tool that gives you freedom and
flexibility to implement tax-saving strategies in a way that makes more
sense for you. If you are a generous
giver, why not do it in the most tax-efficient way? Read more… |
Freedom and Flexibility
One thing that makes DAFs so beneficial is that you
can plan your charitable giving to lower your taxes over multiple years and/or
during specific high-income years without having to decide which charity to
make the donation. Even if you don’t itemize due to the higher standard
deduction, you can use DAFs to itemize your deductions by bunching your
charitable donations while claiming the standard deduction in alternating
years.
To learn more about how bunching charitable
donations helps lower taxes, take a look at my article, “Bunching
Charitable Donations to Reduce Your Taxes.”
DAFs give the flexibility to claim the deduction
when the donation is made, but the monies be granted out to charities at the
donor’s discretion over as long a period as desired, to as many qualified
charities as desired. If you grant to 501(c)(3)s and public charitable
organizations such as most churches, you have options.
Available to
Anyone
DAFs are available to everybody. DAF foundation reports show the median
account balance is only around $20,000. DAFs can be useful for people who
itemize their deductions every year or who combine their donations to itemize
periodically. People who can take advantage the most are charitably minded taxpayers
who are in higher tax brackets, but taxpayers paying lower rates can also
benefit.
Easy to Use
First, it’s important to know that Donor Advised
Funds are actually very simple. Take this
example.
Suppose that every year you
give $10,000 to your church. But
this year you sold an investment property with a high capital gain and you know
you’re going to have a much higher tax bill this year. By giving more money to
charity this year, you’ll get a larger tax deduction, offsetting your tax
increase from the sale.
But you are not sure that you
want all that money to go the one charity. You never know what could happen after
you donate a large sum. Suppose the charity dissolves or starts making
decisions you disagree with and you prefer not to grant a large chunk of money
at one time to one organization.
By donating to a DAF, you get
the tax deduction on the full amount this year and you can decide later when to
give away your money and to whom. You have the freedom to decide how to split
up your grants among different charities and within your
preferred time period.
Another example may be that you are in your peak
income earning years, and therefore are in a higher tax bracket. You may want to
frontload your giving to a DAF to save more taxes now and then use those
donations later to make grants when you retire. (Whereas had you simply waited
to make the donations during your retirement years, your tax savings would be much
less because you will likely be in a lower tax bracket in retirement.)
Quick Facts to
Keep in Mind:
- Contributions are irrevocable and the monies must eventually be distributed to qualified charities (You cannot get your money back).
- If itemizing, contributions are all tax deductible in the year you contribute it to the DAF. If you claim the standard deduction, your donation will not be deductible; but you could still have control over the distributions to your charities. (See my bunching article on how to get a tax deduction if you normally claim standard.)
- You are not required to immediately make grants to charities from the DAF.
- Deductible contributions are limited to 50% of your Adjusted Gross Income (AGI) for cash contributions and limited to 30% of your AGI for donated securities such as highly appreciated stock shares.
- By using an established DAF, the sponsoring organization holding the fund takes responsibility for all administrative work while you the giver get to simply invest and grant the money as you please.
- Cash, appreciated stock, and real estate are all assets able to be deposited into a DAF.
- DAFs are great options to consider with a bunching strategy, but they cannot be used for Qualified Charitable Distributions (QCDs).
DAFs allow you to make irrevocable contributions from your personal assets. After you make your donation, you can claim the gift as a tax deduction up to IRS limits. You name your DAF account, name your advisors, and choose what happens to the funds at your death. You can
- name successors to maintain the DAF and direct the grants, or
- name the charities to which the remainder of the funds will be granted and the DAF be emptied and closed.
Emotional Benefits
DAFs provide you with time, flexibility, anonymity,
and peace of mind. Through DAFs’ structure, they let you spend less time
and money dealing with legal, accounting, and filing costs that would be
required were you to use a different donation process other than a DAF. Not
only is a DAF a simple donation process that can be an integral part of your
tax-saving strategy, a DAF can help you easily contribute donations and take your
time to decide which charities that you truly want to support.
You can spend time considering various charities
and know your funds are being given to the charities you choose. DAFs also give you complete confidentiality if you would like.
Exactly What You Need to Do to Start Your
DAF
Once you've consulted your advisors and know that a DAF is the right choice for you, here are the steps you need to take.
- Make a donating and granting plan (not precise, but specific enough that you can decide how to invest the funds appropriately)
- Identify which of your assets to donate (and when)
- Find a sponsoring foundation that you like (listed below are 3 popular foundations)
- Complete the necessary paperwork to open your DAF
- Contribute to your DAF
- Invest the assets to align with your donating and and granting plan
- Make your grants per your plan (with DAF minimums in mind)
A few
prominent charitable foundations are listed below to help you see which might
be the most appealing to you and your specific financial needs.
- American Endowment Foundation: They require a 0.6% minimum fee with a $500 per year minimum fee, a minimum account balance of $5,000, a minimum of $10,000 to open a fund, and a minimum grant of $250. To find out more about how AEF serves their donors, use this link.
- Renaissance Charitable Foundation: They require 0.6% minimum fee with a $150 per year minimum fee, a minimum account balance of $2,000, a minimum of $5,000 to open a fund, and a minimum grant of $250. To get a closer look at the benefits of using RCF to manage your donor-advised fund, check out this link.
- Schwab Charitable Foundation: They require a $5,000 irrevocable minimum contribution to open a DAF and charge 0.6%/year (billed daily) with a $100 minimum fee, no minimum acct balance, a $5000 minimum starting balance, $500 minimum subsequent contributions, and $50 minimum grants. You can pick your own investments, but you’re limited to 14 mutual funds you can use unless you have more than $250,000. At other foundations, all public investments are available through the brokerage firm used. Feel free to use this link to calculate your annual fees using a Schwab donor-advised fund.
I’ve provided a chart below to give you an
easy-to-compare look at the basics of these three Donor Advised Fund
foundations.
These three foundations aren’t the only options out there, but by comparing what these three prominent foundations have to offer, you can get a better idea of the landscape and how to compare donor-advised funds.
As always, this article is not
intended to be specific advice, but rather to raise your awareness of
things to discuss with your financial adviser and tax preparer. Hopefully they
are collaborating with you already about these things.
You may find the flow chart below as a helpful guide as you discuss it.
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Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
- Liquidity--Retirement assets are not being locked up or annuitized such that capital is not available for emergencies.
- Income—Using an optimized withdrawal rate, an increasing income is produced to combat inflation (unlike many pensions, bank and insurance strategies that are not inflation-adjusted).
- Growth--assets that can combat inflation over a 20 to 30-year period, giving the retiree more income and upside potential under normal and good economic times.
- Safety--manages the myriad of investment risks like market risk, inflation risk, and credit risk. Under worst-case scenarios, if withdrawal amounts are adjusted by using guardrails, the portfolio can still provide a lifetime income.
Here is an executive summary of how to build up a portfolio for retirement in seven steps.
1. Values clarification and goal-setting . Figure out the income objective and capability of your retirement assets in lifestyle terms, then financial terms. In other words, set realistic, specific, financial goals based on your core life values.
2. Asset allocation glide path . Figure out how to diversify your retirement assets among stocks, bonds, and cash, based on your age, risk tolerance, retirement goals, and changing market values.
3. Valuation-dependent efficient frontier . Figure out which areas of the markets are historically inexpensive, and which are historically expensive. Don’t take on more volatility than you need to for the growth you need or desire.
4. Multi-asset class approach . Diversify one more step for more growth and less volatility. Put more money in the specific market areas that are less expensive and less money in the specific market areas that are more expensive.
5. Tax-aware asset location and distribution . Save as much on taxes as possible by figuring out which type of investments should be held in which types of accounts. If you are drawing an income from your assets, figure out the least-costly order for making withdrawals.
6. Investment selection based on account type (qualified, nonqualified) and asset-class propensity and magnitude of outperformance (passive, factor, managed, etc. ). Figure out what kind of investment to use (index mutual fund, factor mutual fund, actively managed mutual fund, single factor ETF, multifactor ETF, passive ETF, individual stocks, individual bonds, Unit Investment Trust, closed-end fund, etc.) based on the account type, asset class, and growth and income needs.
7. Rules-guided rebalancing based on retirement glide path and multi-asset-class approach . Readjust the investment mix based on your changing personal situation and changing market values.
Sign up to receive my free monthly email articles...because you want to make the most out of your retirement
.
Here is a summary of the details backing this approach. Also, click here for more background information regarding my investment philosophy.
1. Values clarification and goal-setting
Investment planning for (or in) retirement starts with retirement planning. You start with thinking about your life goals...your dreams...your ideal life in retirement. It could involve doing no work, working part-time, or doing seasonal work. Your ideal life could be going back to school, spending more time with family, traveling, ministry, etc.
Ask yourself questions like, "What would I want to do if I
didn't need to work for money?" or "What are the most important
dangers, opportunities, and strengths I need to address?" or“Ten years from now, if I am looking back on a successful
ten years, what will I have achieved?”
This conversation allows you to create specific
goals around your most cherished values. And your goals will be unique to you.
You then design an investment plan to help you live your ideal life.
This kind of goal-focused, plan-driven approach minimizes the
chances of making bad investment choices based on current events and emotions.
Instead, you can choose and maintain the
specific mix of investments that can best deliver the results you need--using a
disciplined, research-driven approach.
2. Asset allocation glide path
The next major question is what kind of investments do you need to meet your goals. All investments have risk. Even "safe" investments over long periods have inflation risk. No single investment delivers growth, high income, and safety of principal. The key is designing a portfolio that balances them in a way that supports your retirement objectives.
And this mix may change over time. For example, for most people, it makes sense to gradually decrease their exposure to high-growth, high-volatility assets like stocks (i.e., equities) as they approach retirement. In retirement, it is usually best to maintain a flat equity glide path, dynamically adjusted for valuation. This approach protects you from the retirement-danger-zone risks of portfolio size effect and sequence risk, while allowing you to take advantage of bear markets and market corrections. See How to Navigate the Retirement Danger Zone .
- Liquidity--Retirement assets are not being locked up or annuitized such that capital is not available for emergencies.
- Income—Using an optimized withdrawal rate, an increasing income is produced to combat inflation (unlike many pensions, bank and insurance strategies that are not inflation-adjusted).
- Growth--assets that can combat inflation over a 20 to 30-year period, giving the retiree more income and upside potential under normal and good economic times.
- Safety--manages the myriad of investment risks like market risk, inflation risk, and credit risk. Under worst-case scenarios, if withdrawal amounts are adjusted by using guardrails, the portfolio can still provide a lifetime income.
Here is an executive summary of how to build up a portfolio for retirement in seven steps.
1. Values clarification and goal-setting . Figure out the income objective and capability of your retirement assets in lifestyle terms, then financial terms. In other words, set realistic, specific, financial goals based on your core life values.
2. Asset allocation glide path . Figure out how to diversify your retirement assets among stocks, bonds, and cash, based on your age, risk tolerance, retirement goals, and changing market values.
3. Valuation-dependent efficient frontier . Figure out which areas of the markets are historically inexpensive, and which are historically expensive. Don’t take on more volatility than you need to for the growth you need or desire.
4. Multi-asset class approach . Diversify one more step for more growth and less volatility. Put more money in the specific market areas that are less expensive and less money in the specific market areas that are more expensive.
5. Tax-aware asset location and distribution . Save as much on taxes as possible by figuring out which type of investments should be held in which types of accounts. If you are drawing an income from your assets, figure out the least-costly order for making withdrawals.
6. Investment selection based on account type (qualified, nonqualified) and asset-class propensity and magnitude of outperformance (passive, factor, managed, etc. ). Figure out what kind of investment to use (index mutual fund, factor mutual fund, actively managed mutual fund, single factor ETF, multifactor ETF, passive ETF, individual stocks, individual bonds, Unit Investment Trust, closed-end fund, etc.) based on the account type, asset class, and growth and income needs.
7. Rules-guided rebalancing based on retirement glide path and multi-asset-class approach . Readjust the investment mix based on your changing personal situation and changing market values.
Sign up to receive my free monthly email articles...because you want to make the most out of your retirement
.
Here is a summary of the details backing this approach. Also, click here for more background information regarding my investment philosophy.
1. Values clarification and goal-setting
Investment planning for (or in) retirement starts with retirement planning. You start with thinking about your life goals...your dreams...your ideal life in retirement. It could involve doing no work, working part-time, or doing seasonal work. Your ideal life could be going back to school, spending more time with family, traveling, ministry, etc.
Ask yourself questions like, "What would I want to do if I
didn't need to work for money?" or "What are the most important
dangers, opportunities, and strengths I need to address?" or“Ten years from now, if I am looking back on a successful
ten years, what will I have achieved?”
This conversation allows you to create specific
goals around your most cherished values. And your goals will be unique to you.
You then design an investment plan to help you live your ideal life.
This kind of goal-focused, plan-driven approach minimizes the
chances of making bad investment choices based on current events and emotions.
Instead, you can choose and maintain the
specific mix of investments that can best deliver the results you need--using a
disciplined, research-driven approach.
2. Asset allocation glide path
The next major question is what kind of investments do you need to meet your goals. All investments have risk. Even "safe" investments over long periods have inflation risk. No single investment delivers growth, high income, and safety of principal. The key is designing a portfolio that balances them in a way that supports your retirement objectives.
And this mix may change over time. For example, for most people, it makes sense to gradually decrease their exposure to high-growth, high-volatility assets like stocks (i.e., equities) as they approach retirement. In retirement, it is usually best to maintain a flat equity glide path, dynamically adjusted for valuation. This approach protects you from the retirement-danger-zone risks of portfolio size effect and sequence risk, while allowing you to take advantage of bear markets and market corrections. See How to Navigate the Retirement Danger Zone .
Protecting your lifetime retirement savings from excessive taxes is a crucial part of holistic financial planning. This involves protecting your IRA, 401k, lump sum pension rollover, Social Security, and any other type of retirement account or income stream from crushing tax rates.
So let's be sure to differentiate tax preparation
from tax planning
.
Tax preparation , also called tax return preparation, looks backward, one year at a time, to get the numbers right to accurately calculate your tax liability (and how much you owe or overpaid).
Tax planning on the other hand looks at taxes in the context of your overall financial picture. A tax planner not only looks in the rear-view mirror but will look forward 20 to 30 years at your projected tax liability and ask what can be done to lower your lifetime tax bill.
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If you have savings outside of pretax retirement accounts invested in capital assets (like stocks, bonds, ETFs, mutual funds, precious metals, jewelry, and real estate) which have large unrealized capital gains, this article is for you. You may be missing the opportunity to pay zero taxes NOW instead of 15% or higher rates in the future. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
.
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Originally written on Aug 2, 2018 and updated for tax law changes.
If you are no longer working and have reached the age of 72,
you probably know about Uncle Sam’s rule for you to take a Required Minimum Distribution
(RMD) from your traditional and rollover IRA(s) each year for the rest of your life. You can always withdraw more,
but this requirement is the minimum
you must take or be severely penalized. Fortunately,
this rule does not apply to Roth IRAs. (The SECURE Act of 2019 changed the starting RMD age from 70½ to 72 starting in 2020, but fortunately you can still make a Qualified Charitable Distribution (QCD) starting the year you turn 70½.)
Sign up to receive other helpful email articles on retirement planning--free of charge
.
If you have delayed paying taxes in your pretax IRA, 401(k), or 403(b), etc, there comes a time when the IRS wants their taxes. And if you don’t give them their taxes based on their required withdrawal schedule, you'll get hit with a 50% penalty on top of what you owed.
Along with Social Security and other retirement income, this RMD can significantly raise your tax rate. Also read How to Dodge the Social Security Tax Torpedo . There are not many ways to reduce this tax burden. In the past, retirees have used various deductions including charitable cash contributions and gifting of highly appreciated assets to charities. (The latter not only gives you, the donor, a deduction but also avoids a long-term capital gains tax bill.)
However, with the passing of the Tax Cuts and Jobs Act of 2017 (TCJA) , with its almost doubling of the standard deduction, itemizing deductions won’t make sense for near as many retirees. Ah, but there is still a strategy. But first let’s better understand the RMD.
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The latest book I am reading is “ The Psychology of Money ” by Morgan Housel. Chapter 3 is entitled “Never Enough”. In this chapter, Housel talks about when rich people do crazy things. He tells stories of wealthy people who never had a sense of enough and wrecked their reputations, families, freedom, and happiness because of it. I have also talked to older couples who tell me they once had a much better retirement in view, but the quest for more led them to make unwise investment decisions that left them financially crippled in retirement. The importance of knowing when you have enough is not only vital to when you retire but also how you retire. It can affect how you invest, how you withdraw, and your overall satisfaction before and during retirement. Be sure to read to the end where I summarize a few key takeaways. Housel makes the four following observations in chapter 3 of his book. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
.
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Whether you do mini-Roth conversions over several years or big Roth conversions in a few strategic years, the Roth conversion strategy could save you tens if not hundreds of thousands of dollars over your retirement. This article will get deep into the issues of Roth conversions for retirees and the ten steps to take to be sure it is done properly. Be sure to scan or read to the end where I will give you the simple answer to getting your Roth conversion questions answered. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
.
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Making big financial decisions immediately following the death of a close family member can be dangerous. It is often best to allow some time before tackling big financial decisions. On the other hand, some people find getting immersed in the finances is helpful in coping with the loss. Whatever way is best for you, you will need to give it your
careful attention to avoid big financial mistakes. The different types of accounts have different rules. I'll address the most common types. In the case of the death of a parent or anyone other than your spouse in which you are a non-spouse beneficiary, there are many rules that you must know to make the best decision for you and your family. (In this article, I use the common parent-child inheritance, but the planning strategies can apply to other non-spouse situations.) Your decisions can have major tax and investment consequences, both now and in the future. And some of these decisions have time deadlines keyed to your parent’s date of death. Also, some of these decisions are irreversible. You can download my free Estate Planning Survivor Checklist here
.
So, you don’t want to rush in and make decisions without knowing the rules, and you don’t want to wait too long and be stuck with fewer options. (In this article, I am not addressing estate taxes. As of 2021, only estates valued at $11.70 million or more are subject to federal estate tax. But there are plenty of other tax pitfalls to navigate around. I am also going to focus on liquid savings like investment and retirement accounts, versus real estate which will be for another time.) Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Delaying Social Security makes a lot of sense for many retirees; but there are common pitfalls that can cost you a bundle. As you know, the longer you delay your Social Security Retirement benefit, the higher your lifetime monthly payments are figured to be. This increase in delaying continues until age 70, after which there are no further increases for delaying. This increase for each month that you delay filing is not small, especially considering the current low interest rates. Even after full Social Security age, your payment goes up by 8% per year until age 70. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . Here are the five big mistakes of delaying your Social Security retirement benefit. |
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Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
Serving Cumming, GA, Forsyth County, and the surrounding areas of John's Creek, Alpharetta, Milton, Duluth, Buford, Suwanee, Flowery Branch, and Gainesville
