[Editor's Note: The following first appeared on WCI Network partner, Physician on FIRE. PoF has actually made a bit of name for himself in the blogosphere for writing about charitable giving and donor advised funds in particular. As we come into “giving season” I think it's highly appropriate to bring one of these excellent posts over to WCI. I've somehow acquired the reputation of being anti-DAF. I'm not really, I'm just anti-putting money in a DAF for decades without actually distributing any of it to charities. Don't tell PoF, but I think I'll actually give (immediately) via a DAF in 2019. At any rate, enjoy the post. ]
No, not the candy bar.
In a related post, I shared how I woke up $100,000 poorer on my 41st birthday. This act of portfolio sabotage was self-inflicted; I greeted the news with a smile. The hundred grand is no longer mine, but I now have the opportunity now to use it to do some good in this world that my family and I live in.
I’ve discussed why I choose to donate. Today’s post will describe how I use a donor-advised fund to get the most for my donated dollars.
donor advised fund confirmation
The easiest way to donate to charity is to simply write a check for cash to your favorite charity. As long as you are giving to a bona fide 501(c)(3) charity (there are over a million in this nation), and you receive a receipt, you can include the donation in your itemized deductions to reduce your income tax. This assumes your itemized deductions exceed the standard deduction.
The Easiest Way is Not the Best Way
How can you donate more to charity at a lower cost to you? By donating appreciated assets. That is, stocks or bonds or mutual funds containing them that are now worth more than you paid.
While you may be able to arrange for a donation of your assets directly to a charitable organization, not every organization would know how to handle the transfer. Small, local charities, the kind I like to give to, could be particularly thorny. This is where the Donor Advised Fund (DAF) comes in.
The DAF accepts your donation and keeps your donated dollars in an account that you control. You get a tax deduction in the year you donate, and you can request grants to charities of your choosing at any time in the future.
Some of the larger brokerage companies, including Vanguard, Fidelity, T. Rowe Price, and Schwab have corresponding DAFs, which can easily accept your donated funds, and have easy-to-navigate online interfaces allowing you to dish out the money when you decide it’s time to give.
I actually have a DAF with both Vanguard and Fidelity, and used to have one with T. Rowe Price, but I moved the funds when I made the switch to Vanguard with my overall investment portfolio.
I like the Fidelity fund for the lower minimum grants compared to Vanguard ($50 vs. $500). It also has a lower minimum to get started ($5,000 vs. $25,000). But I use the Vanguard fund as well, largely for the ease of transfer of my mutual funds, which happens literally overnight, as I will detail below.
Goodbye, Capital Gains
The reason it’s more advantageous to give appreciated assets than cash is the elimination of capital gains taxes. There aren’t that many ways to obviate capital gains — I outline the best ways here — and some are almost never advisable, like death for instance. I would advise against death as a tax avoidance strategy 100% of the time.
When you donate appreciated assets, neither you nor the receiving charitable organization owe capital gains taxes. Donating assets can be a particularly powerful strategy if you have large gains, especially if it’s a fund that may not be well suited for your portfolio, like the ones discovered by this random guy, who also happens to be a physician.
I opened my first DAF in 2013 when I realized my taxable account was a pretty random collection of actively managed funds and index funds with unnecessarily high fees that didn’t make much sense in my portfolio. I had been investing early and often, but not especially well.
The markets had been soaring since I started buying mutual funds in 2009. I had substantial gains, was living in a high tax bracket, and was feeling generous. In an effort to simplify, I sold some of the lower performers, donated some of the higher performers, and did more of the same the next calendar year.
My current collection of funds were all purchased within the last few years, so the gains aren’t huge. Still, they’re there for the giving. In order to decide which funds and lots to give, I needed to take a close look at my mutual fund holdings.
I have four funds in two general categories (U.S. Stock and International Stock) in my Vanguard taxable brokerage account. If I were sticking with a simple three fund portfolio, I would have two funds here, but I like to take advantage of tax loss harvesting, so I’ve ended up with partner funds in the account.
Here’s a look at the gains in funds I’m holding. You’ll notice it’s all green. Any red (tax loss) has been harvested.
I’ve got $151,367.52 in gains, most of them short-term. While I would love to get rid of the gains only, it doesn’t work that way. You have to give away specific lots.
I created a spreadsheet from the information Vanguard supplies to assist in my donation decision-making. I added the “% Return” column, using a simple formula. All the rest of the data came straight from Vanguard. I have “Specific ID” chosen as my cost basis method, which is important for both tax loss harvesting and donation purposes. The overall average gain of my lots in the taxable account is 15.7%. It would behoove me to part with the lots with above-average gains. The international funds have gains below the threshold, so I’ll hang onto those. The US stock funds (VFIAX = S&P 500 index, VTSAX = total stock market index) had better gains, and the funds held the longest had the largest gains. I chose enough of them to add up to $100,000 and pulled the trigger.
You can choose which funds to donate online, but unlike when you sell or exchange, Vanguard’s site will not allow you to select specific lots. Grrrrr… It can be done with a phone call or letter of instruction, but this is the 21st century, darn it. I shouldn’t have to send snail mail or talk to anyone, for any reason, ever.
This hiccup was inconsequential, as their preferred method (FIFO) of donating the lots held longest corresponded with the highest returns. These are the lots I want to part with to discard the most potential capital gains. Altogether, the $100,000 I donated had a cost basis of about $78,000, for a $22,000 long-term capital gain.
Calculating the Tax Savings
If I would have sold the funds and donated cash before donating the $100,000, I would owe capital gains taxes on the $22,000. How much would that cost me?
Since I had held all of these lots for more than a year, they would all be taxed at the long-term capital gains (LTCG) rate. So, 15% of $22,000 = $3,300, right?
Wrong. Add in my state income tax of 9.85%, the NIIT / ACA surtax of 3.8% to arrive at my LTCG tax rate of 28.65%. If I had a higher income — enough to put me in the 20% federal capital gains tax bracket — it would be 33.65%. In California, the LTCG tax can approach 37%. So, donating appreciated funds rather than selling and donating cash saved me $22,000 x 28.65% = $6,300.
Then, of course, there is the benefit of deducting $100,000 from my taxable income. It can get pretty complicated to calculate this one, and everyone’s situation will be different, but factoring in medicare (FICA), federal income, and state income tax reduction at my marginal tax rate, I can expect a tax refund in April of at least $42,000 based on this one big donation.
While the $6,300 is only a relative gain compared to selling funds now (which I would never do), the $42,000 tax refund is very much real, and it should hit my account within days of filing my taxes this spring. In other words, when the dust settles, this $100,000 donation cost me $58,000, and reduced my remaining cost basis in my taxable account by $22,000.
Donate Now, Give Later
The benefit of growing the fund while working is obvious. Our tax code makes it much more beneficial to give when your income is high. If I were to wait until the paychecks stop coming to build up our DAF, the tax breaks would be much smaller.
It makes good sense to give from your surplus, and the surplus will change before and after retirement.
Right now, my surplus is money. I have financial independence, and I’ve already worked one more year since realizing it. Soon, despite the financial setback I instigated, I will have my financial freedom.
In a few years, I don’t anticipate spending nearly as much time, if any, in clinical medicine. Then, my surplus will be time. If I’ve satisfied my family and personal needs for my time, I can afford to be more generous with my remaining free time, which is something I don’t do a whole lot of right now.
i did find 2 hours to ring the bell on black friday
As I mentioned previously, I don’t plan to give out $100,000 to my favorite charities right away. Much like I don’t spend all of my paycheck when it hits the bank account, I won’t give away all the new DAF money right away, either. Rather, I’ll use it to give an extra $5,000 or so this year.
I have a goal of having a DAF equal to 10% of my investments before retiring early. After the latest donation, the sum of my Fidelity and Vanguard DAFs have more than doubled to between 8% and 9% of my investments. One smaller lump sum next year, which is potentially my last full year working full time, ought to get me there.
Treat the DAF Like Your Nest Egg
A $250,000 DAF will allow me to comfortably give away at least $10,000 a year indefinitely using a 4% safe withdrawal rule as a guide. I won’t receive any further tax deduction for the annual gifts; I’ve already taken them at the best time, when my income and deduction potential are at a maximum.
The money is invested according to my specification. I keep an aggressive allocation because this is money I can afford to lose but would like to see grow to its fullest potential. Using Vanguard’s Total Equity allocation, I am invested in an automatically rebalanced portfolio of 55% S&P 500, 15% Extended Market, and 30% International Stock index funds, with an expense ratio of 0.08%.
In addition to the expense ratio, there is a 0.6% account fee. This closely approximates the tax drag on my taxable account as a result of about a 30% LTCG gains tax on a 2% dividend. Fidelity and Schwab have similar fees.
There you have it. The best way to donate a hundred grand. You don’t need nearly that much to get started, though. For $5,000, you can get started with Fidelity Charitable.
There’s no need to wait until you’re close to retirement to start benefiting from a donor-advised fund. There is some advantage to giving the most during your highest salaried years, so if you are on a steep upward trajectory, it might be wise to wait a bit. On the other hand, there’s a penalty to waiting until after your peak earning years to fund one.
For more information on Donor Advised Funds, see my posts on the topic:
Thank you for this detailed article. I appreciate your willingness to give detailed information.
I agree with the idea of periodic lump sum contributions to the DAF.
My wife and I have done this with our Fidelity Charitable acct.
We each rolled fairly large IRAs to Roth IRAs.
There was a substantial portion that was taxable.
We contributed an equivalent amount to the DAF.
Each time we used appreciated securities, avoiding tax on the gain.
We also made large contributions to the DAF several times when medical office buildings were sold.
The funds were then available in a subsequent year for large contributions to a church or school capital campaign.
This smooths out the difficulty of receiving high income one year but giving in a different year.
Tax record keeping is massively easier with our DAF. One donation, that’s it for tax records.
We try to give all charitable giving through Fidelity Charitable.
Fidelity also helps vet your proposed charity with links to investigate a 501(c)(3) organization.
However, most of our giving is to organizations in which we are personally involved.
The 4% distribution is awfully low.
As you become financially independent, you should be able to go well above a tithe.
And for some programs, a large one time donation will have huge impact.
You are preparing for that!
Thanks so much.
And thank you for your generosity. You’re right on the 4%. I can be more aggressive for a couple of reasons. For one, if the funds were to run dry, we wouldn’t be destitute (as opposed to our nest egg funds). Also, I’m still contributing — by donating half of my website profits, I anticipate making additional six-figure contributions to our DAF in the future.
Cheers!
-PoF
One of the best reasons to get rich is to be able to give it away to make the world a better place. Excellent post!!
Absolutely. My views on money and how to use it have changed dramatically since I realized we have all we should need.
Cheers!
-PoF
I think that using a DAF for charitable giving is just a supercharged version of “donation-bunching” where people try and maximize their deductions by doubling them up in alternate years. It is especially valuable since the Trump tax bill has doubled the standard deduction, which will cause most people with a paid-off mortgage to lose the tax benefits of the charitable deduction on Schedule A. Starting a DAF allows you to “donation-bunch” a decade’s worth of charitable contributions in one year so you can ignore Schedule A for the next nine. My DAF contribution in 2017 also allowed me to offset the taxes on a large rollover from a traditional to a Roth IRA.
The downside is that since I am not making many charitable donations out of yearly income any more, all of the deductions we used to take for donations of household items to charity are lost. Of course, my wife sees that as a benefit because her major contribution to our income tax process was keeping a tally of what items we donated and the approximate value of each. She complained bitterly about having to do that and is very happy to just donate stuff without needing to keep track of the paperwork anymore!
Yes, that’s a use for a DAF. But you know what does the same thing and gets the money to the charities where it can do the good even faster? Skipping the DAF. You don’t need a DAF to bunch donations.
Individual with paid-off mortgage, no state taxes (I wish!), $2K/yr property taxes, makes $10K in charitable contributions per year:
Non-DAF: $12K standard deduction offsets the $12K of taxes and contributions annually. The individual recognizes no tax benefit for $100K of contributions given one year at a time for a decade.
DAF: $100K DAF contribution in year 1 results in a $100K deduction. In years 2-10, he has $10K of his $12K standard deduction to apply to reducing his AGI rather than offsetting the annual donation expenditure.
Dr. DAF makes the same charitable contributions on the same schedule as Dr. Non-DAF, but realizes $190K of deductions from income, and that doesn’t even allow for 1) earnings on the DAF raising the contributions in the later years beyond $10K; and 2) the savings that could be gleaned by using the DAF contribution and the additional $10K/yr from the standard deduction to allow for a Roth conversion that would save taxes on any gains on the converted money.
You make the exact same total amount of contributions on the exact same schedule but shelter $190K of income from taxes. What’s not to like about this?
You’re missing my point. If you can put $100K into a DAF in year 1, you can give $100K to the charity in year 1 and get the same deduction. By using the DAF, you’re getting all the benefit of an immediate contribution but the charity doesn’t get it for a decade. That’s why I often refer to it as a “jerk move.”
Yes, it can make money in the DAF, but the charity can also invest it and get the same benefit if they so choose or benefit from getting the money earlier thanks to the time value of money.
Actually, where the DAF really adds value here is with the normal rhythm of donating. Most of get small requests and like to tithe to various groups annually, even if committing a large amount to one focused area may be actually more rewarding for the donor and recipient. The DAF makes this so much easier than what I currently do, which is to donate stock shares piecemeal every year. And it allows the bunching that is more tax friendly with our new code. Otherwise, yes if you know you’re going to target one group, go ahead and give it now rather than bother with a DAF.
Recently I was researching any low cost DAFs. Nature conservancy provides a DAF where you commit a certain proportion to them. Use some dollars for others. This sounds like a reasonable deal, and I hope more of these show up.
I agree the convenience and anonymity are worthwhile benefits I find attractive.
I should correct my fee objection, since it is tempered by what PoF says about the tax drag of the taxable account– what you would pay in qualified dividend taxation (esp in CA) on a broad index fund is comparable to what the admin fee for these DAF accounts.
A comparison of different options & custodians such as Schwab vs Vanguard vs less known sponsors, seems like a good future post topic. It appears there are low cost options among these providers, with Fidelity and Schwab having lower minimums for contribution and donation amounts than Vanguard.
Yeah, my tax drag in MN is nearly identical to the 0.6% fees the DAFs charge. That was an interesting revelation and it gives me a great rebuttal to those that complain about the high fees.
I also agree that the ability to bunch in this way is even more valuable now that the standard deduction is so high at $24,000. It has been a relief to not have to keep track of every last item that goes into the donation box this year since we’re not itemizing. But now we’re stockpiling stuff to donate in 2019 since I plan to make a similar donation to our DAF next year.
Cheers!
-PoF
What would the fee be for the charity to invest it? Exactly.
Thanks for reminding us about DAF. I have resisted it so far, because like the above reader (Pevend), I plan to bunch donations (although charities are not happy about adjusting to this trend, of course) The DAF is so elegant versus transferring shares to each charity, however, the fees bother me. Schwab and Fidelity are copy cats, about $100 minimum to 0.6% fee plus higher than average fund management fee , at least 0.5% for their composite/balanced funds. Over time, that makes direct share transfers worth the pain.
This reader’s use of doing Roth conversion during working years paired with DAF contribution is great idea. Alternative is to do conversions during early retirement when income is lower. Also don’t forget most of us will stay in high brackets when getting IRA/401k RMDs and those can be directly sent to charity to reduce taxable income, so I differ with WCI on idea that there is a limited window for HNW docs to use these tools.
If you’re doing QCDs, you don’t need a DAF. I think you mean you differ with POF. Sounds like you agree with me.
I am thinking DAFs help while you’re working and converting to Roth, whereas QCDs after age 70 1/2.
(can’t QCD earlier, unfortunately-this is why I like your blog , forces me to learn this stuff)
btw Prevend = pof ?
No, that’s not PoF. He usually signs his comments as Physician on FIRE. He is the author of the piece though.
The expense ratios in Fidelity’s DAF are as low as 0.015%. So the total fees are 0.615% if invested in the lowest cost index fund. That’s on par with the tax drag when leaving the funds in a taxable account.
Private foundation fees are definitely higher.
Best,
-PoF
Thanks for an excellent article. I suggest the following clarifications/additions:
The donation of appreciated capitol and real property extends to more than just securities and large DAF can handle many of these items, e.g., IPO stock, restricted stock, privately held business interests (C-Corps, S-Corps, LLCs, LPs), real estate, etc.
Appreciated assets are valued at fair market value, if they are subject to longterm cap gains. Short-term appreciated items are valued at basis cost, limiting the income tax deduction.
The donation of appreciated assets is limited to 30% of AGI. Excess can be carried over to subsequent tax years, generally restricted to 5 years.
Grants to a DAF cannot be used to fulfill a legally enforceable pledge by the donor.
The grantor must not receive anything of value in return for the grant. No tickets, dinners, etc., as the “Full Deduction Rule” applies.
Grants can be made anonymously.
Generally, grants can only be made to IRS certified 501(c)(3) charities or to foreign equivalents.
Many DAF can be legacy vehicles, fulfilling charitable goals after the donors death.
DAF can be a beneficiary of an IRA, estate, trusts, life insurance, etc., potentially reducing taxation of heirs.
Dr. Dahle’s concern regarding DAF being used to reduce taxes via immediate donations, without subsequent timely grants is valid, but seems to be of modest concern, based on recent data from The National Philanthropic Trust. Aggregate grant payout rates from donor-advised funds exceed 20% annually, for every year on record. The payout rate for 2017 was 22.1%. The payout rate for DAF is almost 4 times the private foundation payout rate.
I guess if you’re impressed by 20% maybe it can be called modest. I’d like to see that figure be 90%+.
My apologies for misinterpreting your concern level. Your preference for 90+% payout rates implies you would prefer most/all charitable conduits be eliminated, as if this was a mandated payout rate, they would offer no benefit and would cease to exist.
A significant part of the growth of DAF assets is from private foundations donating to DAF. Private foundations must grant 5% of their assets each year and granting to a DAF qualifies. I am against this, as it bypasses the intent of the applicable tax law. Additionally, many smaller private foundations are closing down, converting to DAF. This significantly reduces their overhead, tightens up the kind of grants they can make and is probably beneficial in the long run. Although I do not have hard data to back this contention, I suspect that the private foundation funds moving to DAF tend to drive down the average payout rate, as I think it unlikely foundations that were granting little more than 5% suddenly start granting 20+%, once the funds are in a DAF. If this is true, the payout rate from non-foundation donated assets is higher.
I tend to view these types of conduits more charitably (pardon the pun), as I suspect many use them as I do, granting more per year, from my DAF, than I would donate directly each year. I am able to budget more for charity, since I am able to more effectively reduce my tax burden.
I feel tools may be used for good or ill, but in and of themselves have no innate moral compass. Individuals must make decisions on the ethics of their use and society must weigh the good, the bad and any unintended consequences. Perhaps naively, I prefer to believe that the majority of people who use these conduits, do so to increase tax efficiency and in-turn donate more than they would otherwise.
Honestly, if I were writing the law, I wouldn’t allow the taxpayer to get the charitable donation until the charity actually gets the money.
I mean, I guess it’s better than nothing (it does have to go to charity eventually) but I only give you half the credit for funding a DAF. You can have the other half when you distribute it.
Great points, all of them. I’ve touched on some of them in different posts, but not all that you mentioned. The fact that short-term gains are not deductible is an important one, but usually your assets with the most gains will have been held greater than one year.
I believe I’ve undersold two of the greatest benefits of using a DAF: the ability to make donations anonymously and the lack of reporting requirements with each grant made from a DAF. You can donate once, take one itemized deduction and donate hundreds of times from that lump sum.
Cheers!
-PoF
I find it somewhat comical following the debate between POF and WCI regarding DAFs whilst there is a 76 comment thread on the WCI Forum regarding whether or not one should be obligated to donate to charity at all. I certainly commend and respect WCI’s commitment to charitable contributions but find the DAF to be a vehicle that works very well for me for many of the reasons outlined by POF. In particular, it was very advantageous (from an admittedly less than altruistic tax standpoint) to fund the our DAF at the end of 2017 given the federal tax law changes beginning in 2018. I fully understand that it would probably be better overall to just make a one large time donation and not donate at all for the next 5-10 years (from the charity’s standpoint), but it feels better donating every year, and we might not always want to donate to the same charity or charities every year.
Okay, my new position is you get half the credit when you put it in the DAF, and half when you actually distribute it from the DAF instead of it being a jerk move. 🙂 Seriously though, I am planning to open one the first week of January.
I’ll be sure to give you partial credit! 😉
It does sound like you’ll be following up shortly with a donation from the DAF to get that full credit.
Glad to hear you’ve come around!
-PoF