Many people of heard about Donor Advised Funds (D.A.F.) but not everyone knows how powerful they can be to leverage charitable giving. In today's episode we talk about situations where Donor Advised Fund makes sense, the of the tax savings that a DAF can bring, and how it can help facilitate happiness through giving.
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TRANSCRIPT:
Bridget: Hey John, we had a client ask about donor advised funds, and I thought, “Jeez, we haven't even done an episode about this very important topic that we both use a lot.” So we're going to have this episode be about donor advised funds. By the end of this episode, you'll understand what a donor advised fund is, what the advantages of them are, and what situations are best for using them. Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I have a fee-only financial planning practice in Middleton, Wisconsin. And before we jump into donor advised funds, I just want to remind everybody to hit that subscribe button. That helps other people find this good content on YouTube, and it helps us improve our visibility. So please hit subscribe. Bridget, let's talk about donor advised funds.
Bridget: Yeah. So you had a great phraseology. You called donor advised funds a mini foundation. So why don't you tell me how you talk to clients about this.
John: Well, sure. Donor advised fund or DAF is this buzzword that you hear around, and people might say, “What does that even mean?” But people understand what a foundation is. Rich people give money and there's the XYZ Family Foundation and that really is to me what a donor advised fund is. For a foundation, you have to have legal documents and a separate tax return, and you have to have a lot of zeros in the portfolio for it to make sense.
With a donor advised fund, you don’t have to be one of the Rockefellers. If you want to set up a mini foundation, you can do it with just a few thousand dollars. There're no administrative costs. It's really easy to do. It's kind of like having just another account at Schwab or Fidelity, but it's this little mini charity. So that's how I describe them. How I think it really works is just being able to do that on a micro level. It can be really powerful from a tax standpoint and a control standpoint for everybody.
Bridget: Yeah, so we're going to talk about the different client situations we see where it makes the most sense. The first one I see is for people who are donation oriented. Some people want to give away some money, but they have appreciated stock. So they've had stock that's gone up. Maybe it's even employee stock purchase plan and the stock has gone up. They have what we call a concentrated position. But they're thinking, “I don't want to pay capital gains on all this.”
And so, we open a donor advised fund and then you can just transfer those shares to the donor advised fund and the person gets the tax deduction for the full market value, so they don't have to pay any tax on the capital gains, and you get the tax deduction. You get the tax deduction for the full market value, and you don't have to pay any capital gains. It's win-win from a tax standpoint.
John: Yeah. That's the ideal situation. I just want to jump in for one second. Structurally, it is like a little separate account, but what happens, just as you described Bridget, is when you put this money in—whether it’s a stock that's going up, a mutual fund, or even just cash—your donor advised fund, your separate account at Schwab, is technically a charity. So I've given that money to charity, but it's not United Way or my church or whatever.
It's my little donor advised fund. And then from that fund, I can make distributions. I can say, “Hey, from my donor advised fund, send money to United Way, send money to the Humane Society, send money to my church,” and the distributions from that account go to charity, but my tax-deductible charitable contribution comes from putting that stock or that cash into the donor advised fund. I just wanted to point that out. That's the structure. I just wanted to get that out there before we start talking about these great strategies.
Bridget: Right. The first thing is that you put the money in, you get a tax deduction, and then you have the money in this account, which you can donate at your leisure. That's the first situation that we see a lot. And sometimes, we do some offsets, too. For example, if somebody's got a big position from some employee stock, we'll say, “Okay, we'll put some in your donor advised fund, and then we'll sell some, and you'll have some offsetting capital gains.” And it's very sweet. We love it from a tax perspective.
John: Yeah. Income here from selling, and tax deduction there from donating. Wipe things out. That's awesome.
Bridget: Yeah. So it could be used in both of those situations. Another strategy is what they call bunching. I don't know who came up with bunching. This is for the people who don't usually itemize but give a lot of money away. So say you give away $10,000 a year or so, and you don't meet the limit for itemizing, which depends on if you're single or married.
It's pretty high, so a lot of people don't itemize anymore. And so, what you do is you save up maybe $20,000 or $30,000, and you do a donor advised fund every few years, and then you take the deduction for it then. And then you again distribute this money to charities at your leisure. So it helps you get the tax advantage of donating when you don't itemize.
John: Yeah, those are some of the exact strategies that we use for clients here. The other one that comes into play for us often is as somebody is approaching retirement and they say, “Listen, this year, next year, my income is going to be pretty high, so my tax bracket is also pretty high. And then when I retire, I've got cash in the bank, I've got I bonds or CDs I'm living off of. And in two years my tax bracket is going to be maybe zero or 12% or something.
So I want to take a tax deduction today at my current rate of 24%, because in the future I'm going to be lower, but I don't want to give a ton of money to United Way or the church. I don't want to give it all to them right now, but I want the tax deduction today, so I can put the money in the donor advised fund and give it away at my leisure from the donor advised fund.”
If I do this, then I can say, “Maybe I’ll give $5,000 a year to my church, so maybe I'll take four years of donations. I'll give $20,000 to my donor advised fund, because what if I change churches or move away? And so, then I can control the timing of the tax deduction and I can control the timing of the distribution, when it goes to the charity, as opposed to having to pick one or the other of those things.”
Bridget: Yeah, I love that strategy. I remember Bert Whitehead talking about it. It's a matter of figuring out how much you want to donate every month when you retire or every year, and then make the big donation for say, ten years even, when you're still working, and it really helps you pay less in taxes.
John: Yeah, I'll tell you the one other thing that we use. The things you described are exactly on point. When you've got an investment that's gone way up, great, you can make a donation. And I want to point out that you can give appreciated money, that is money that's gone up. For example, I bought Apple stock. It went way up. I can usually give that. Many charities have a brokerage fund. I can give that to my church. I'm on the Education Foundation board here in Middleton. We have a brokerage account.
You can give your appreciated stock to that board and that foundation, and they can sell it. So it's not like the donor advised fund is the only way to do it, but having that control over where it goes and when it goes is really important with the donor advised fund, which you don't get when you give it directly to charity. The other thing that comes into play is if you think about what we just described. I give money to the donor advised fun. That's technically the charitable deduction, and then the donor advised fund gives money away.
I only have to keep track of one donation for the year. We all have experience with making a donation here and a donation there, and you get those receipts and you got to track all those things. Well, listen, if I'm going to give $20,000 to my donor advised fund, even if I'm going to give all that money away this year, then I can give $100 here and $500 there and $200 there, and the donations from my donor advised fund to those charities isn't the tax deduction.
It's that one lump sum that goes in. So from a record keeping standpoint, we've got some folks who say, “Listen, I don't care about the timing on things. I don't have stock that's gone up that I want to donate. I just don't want to have to keep track of 200 different receipts for all my charitable donations.” That can really streamline things and make it an easier way to keep track of your charitable giving.
Bridget: Yeah, I had one client talk about how easy it was and how much she enjoyed giving that way, because she could go on the website and just type in, “I want to give $200.” And then there was like a drop-down list so she could search all the charities. She didn't even have to mess around with figuring out the address or how to deal with the check.
John: It was just done.
Bridget: Yeah, it completely simplified the process. And sometimes when you're giving money, you don't get ten times as much happiness if you donate ten times as much. So if you donate $1.50, you get almost as much happiness as if you donated $15. And I think a lot of people think $15 is pretty a small donation anyway. So just little amounts can really improve your happiness, yet from a pragmatic standpoint you might ask, “How do you even give away smaller amounts?” I think there is a minimum with the accounts of how much you can give away. Maybe it’s $50.
John: Something like that.
Bridget: But again, it just simplifies record keeping and simplifies your interaction with the charity, and it can maximize your happiness. Another thing about donor advised funds is you can give it anonymously. For a lot of people, if they don't get credit for a donation, it makes them happier. I don't know if it makes the charities happier because I think they want to advertise it, but not being the person who takes credit, again, it's associated with some more happiness.
John: I wanted to bring up just two downsides or things to be aware of. There're not many downsides to donor advised funds. It really is a slick deal. However, I've come across two things for people to be aware of. One is when you make a donation to a smaller charity. I live in Dane County. The United Way of Dane County and large churches have already been vetted. It recognizes that's an acceptable charity and sends that money right away.
If you live in a small town, however, it may be different. We had somebody up in northern Wisconsin who wanted to give to the local charity. It was legitimate, but what Schwab and all the donor advised fund housing firms do is make sure that it's a qualified charity because you can't give it to an individual or something else, so it can take a little bit of time if you're in one of those smaller places. That happened to me with my church. It was a smaller church, and it wasn't on their radar.
Now anybody else who goes to St. Dunstan's will be able to find that, because it's been approved. So that's one thing. And the other thing is we had a client whose company would match donations up to a certain amount. If I send in a check for a thousand, then they give a thousand. That's awesome for the charity. This particular business, however, didn't have a great way of matching when it came from the donor advised fund.
And so, if you're part of a matching program, you might just want to double check. That was a sticking point in that situation. Those are the only two things. One is a little bit of a timing thing, the other was that matching thing. But those are the only things I know of for drawbacks to using a donor advised fund. So with that, I think it's a good place to wrap up our conversation. I'm John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both looking for new clients right now, but we also belong to the Alliance of Comprehensive Planners at acplanners.org. And if you want to find an advisor in your area, you can check out that website, and they can help you out.
John: That's right. And don't forget, hit that subscribe button.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.