4 smart contribution strategies with a donor-advised fund
These financially savvy charitable contribution strategies can help you maximize giving with a donor-advised fund.
A growing number of donors are familiar with the simplicity and tax benefits of giving with a donor-advised fund, including the ability to take an immediate tax deduction and spread giving over time, invest donated funds for potential growth and easily contribute appreciated securities.
But even if you’ve embraced using a donor-advised fund, you may not be taking advantage of all of the charitable contribution strategies that could help you maximize your giving and minimize your tax burden. Donating appreciated securities as part of your portfolio rebalancing can help keep your overall finances robust, as can donating a high-performing stock and buying shares at a higher cost basis. And you can more easily give for years to come by scheduling recurring donations or donating windfall income from events such as business exits—lowering your tax burden in an unusually high income year. These savvy strategies are worth a discussion with your financial advisor.
Don’t rebalance your portfolio without also thinking about your charitable giving
If you’re a charitably inclined investor who uses an asset-allocation approach to your portfolio, the rebalancing process is a ripe opportunity to help increase your support to nonprofits while managing the overall health of your investments.
“Portfolio rebalancing is a periodic, disciplined strategy of selling the winning asset classes in your portfolio and reallocating that investment into a different asset class that’s more of a laggard,” said Tony Oommen, vice president and charitable planning consultant at Fidelity Charitable. “Of course, when you make that sale, you’re realizing capital gains if it’s in a taxable account.”
That’s why, according to Oommen, incorporating charitable giving strategy when you rebalance makes good financial sense; instead of simply selling long-term appreciated securities, “periodically cherry-pick the ones with the most appreciation and donate them to a public charity with a donor-advised fund program instead. You can potentially eliminate taxes on capital gains and be eligible for a charitable tax deduction on the fair market value of the stock.” The strategy does more than align your portfolio with the allocation levels that make the most sense for you; your donation also can be invested to potentially grow, tax-free, while you decide which charities you’d like to support.
The end result is you’re able to give more to charity, but your taxable investment portfolio is more tax-efficient.
“This is a way to take advantage of your charitable intent to make your taxable investment portfolio more tax-efficient,” Oommen said, especially given the simplicity of donating stock to a charity with a donor-advised fund program, like Fidelity Charitable.
Donate a high-performing stock … and then buy new shares
What if you have an asset that has appreciated—one that could help you fund your charitable giving—but you’d still like to keep it in your portfolio? Donate it to a public charity with a donor-advised fund program and then purchase new shares of the same security. Your newly acquired security will have a higher basis than the original, minimizing your future tax liability if you ever sell it and maximizing current tax advantages for donating the original shares. It’s a smart idea if you already plan to make a gift to charity, especially if you or your advisor thinks the security still has upward potential, Oommen said. Even if you do not buy the same security back, if you replace the value of donated positions by replenishing a taxable investment account with cash and then move that cash into your investment allocation, you will raise the overall cost basis of your portfolio, saving in future taxes.
Here’s how it works. Let’s say you’d like to contribute $10,000 in cash to charity this year, which would generally make you eligible for a $10,000 income tax deduction. But if you have $10,000 in stock that you donate instead, you’ll still be eligible to claim the same income tax deduction, plus you’ll also be eligible to eliminate any capital gains tax on the difference between the price of the stock when you bought it and when you donated it.
Sometimes, your most appreciated assets—generally the best ones to donate because they offer the greatest potential tax benefits—are also the ones you may wish to continue to hold in your portfolio. Fortunately, nothing prevents donors from purchasing new shares of stock to replace the donated shares. In the example above, you could use the $10,000 cash you were planning to donate initially to purchase the stock again.
Not only does this strategy allow you to continue to invest in a desirable asset, it can help you with long-term tax efficiency. If the stock continues to increase in value, thanks to the higher basis, you’ll owe less on your future taxes if you decide to sell it. And if the price sinks, it’s more likely that you will be able to harvest a capital loss to offset any realized capital gains.
“The end result is you’re able to give more to charity, but your taxable investment portfolio is more tax-efficient,” Oommen said. “And it doesn’t cost you anything to do so.”
Opt for automatic funding of your donor-advised fund
Research in behavioral science tells us that people tend to delay on taking actions that may not require immediate or urgent attention. Giving to charity may not be a top priority in donors’ minds—which may be why many people end up scrambling to make all their planned donations at the end of the year. But when you set up automatic donations to a public charity with a donor-advised fund from your bank or brokerage account at monthly, quarterly, bi-yearly or yearly intervals, you can turn a small donation to charity into a large one over time and do so with set-it-and-forget-it convenience. In the same way that automatic deductions and opt-out plans for retirement savings help people save more, automatic contributions can help you reach your personal targets for giving and creating an impact.
Whether you plan to donate cash or securities, establishing automatic contributions rather than a lump-sum donation will regularly increase the amount available to be invested so it has the potential to grow, tax-free, throughout the year, until you’re ready to recommend a grant to charity.
You can use this strategy through recurring donations of cash from your bank account to fund a donor-advised fund or by setting up a recurring order to donate stock from a brokerage account. (If you prefer more control over when stock will be donated but still want to use this option to fund your donor-advised fund on a regular basis, you can speak with an advisor about setting a target price on a security you’d like to give. An advisor can help you donate the asset to a public charity with a donor-advised fund when that value is reached.)
Business exits are a particularly smart time to think about making charitable contributions.
If your main source for giving is your income, spreading contributions over the course of the year can also help you incorporate charitable giving into your overall household budget.
“Giving automatically can be useful for high-income individuals who are approaching retirement, and who want to continue to give charitably at the same levels after their careers,” Oommen said. “And it can make some sense to get a better tax benefit in the years when they’re still working and their income is higher.”
Pre-fund charitable giving during a high-income year
Whether you’d like to continue to give at your current level in retirement or you’re trying to grow a balance over time to be able to recommend a substantial grant to a nonprofit you support, a donor-advised fund can help you leverage tax advantages to sustain future giving.
One key way to do this: Offset higher than normal income years with a larger than normal donation to a public charity with a donor-advised fund program. Examples of events that would trigger higher income include exercising stock options, selling real estate or a business, selling and diversifying a concentrated low-basis stock position and receiving a large bonus or severance package.
Business exits are a particularly smart time to think about making charitable contributions, Oommen advised. “For many people who have owned or started a business, the year they sell their business is typically the biggest tax year of their life. They can fund charitable giving potentially for the rest of their life by setting aside some of that business stock prior to it being sold and making charitable donations with a planning vehicle, such as a donor-advised fund. That’s the best example of why pre-funded future giving makes sense; it allows you to take advantage of dedicating assets for charitable use and recommending grants to charities over time.”
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