Most Americans with any degree of investable assets are seeking ways to minimize their overall tax bill. In retirement, when people are withdrawing from their accounts, taxes on required minimum distributions and Social Security income can add up fast.
While there’s no way to avoid paying income taxes altogether, there are vehicles that allow investors to receive specific tax benefits.
One such vehicle is a donor-advised fund, or DAF. These are investment accounts established as an Internal Revenue Service-qualified 501(c)(3) public charity.
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A donor-advised fund allows a donor to make a charitable contribution and receive an immediate tax benefit. Over time, whenever he or she is ready, the donor recommends grants from the fund. These grants are awarded to the account owner’s specified charities.
In a nutshell, here is how donor-advised funds work: The donor contributes to the fund and receives an immediate tax deduction of the maximum amount allowable by the IRS. The contribution grows tax free. The donor is free to select qualified charities to benefit from the funds.
Tax benefits of using a donor-advised fund include:
— Income tax deduction — you get an income tax deduction the year you contribute to a donor-advised fund. The IRS has certain limitations, depending on the donor’s adjusted gross income. It’s best to consult your financial advisor or account for specifics about the deduction in your situation.
— No capital gains tax — you face no capital gains tax when on gifts of appreciated stocks, bonds, real estate or other types of assets.
— No estate tax — a donor-advised fund is not subject to estate taxes.
— Tax-free growth — investments in your donor-advised fund appreciate free of any tax liabilities.
— Alternative minimum tax reduction — for donors who are subject to the alternative minimum tax, contributions may reduce that burden.
Fortunately for investors, there are numerous sponsors of DAFs nationwide. Many of the well-known financial services firms, such as Fidelity, Schwab and Vanguard launched separate 501(c)(3) organizations to sponsor donor-advised funds. Other large sponsors include the American Endowment Foundation and the National Philanthropic Trust.
“We find that many of our donors are much more thoughtful or strategic about their giving than just simply doing checkbook giving,” says Matt Nash, senior vice president of donor engagements at Fidelity Charitable, a 501(c)(3) organization established by Fidelity Investments in 1991.
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Nash compares that level of consideration with the more typical process of writing checks to charities at year’s end to qualify for a tax deduction.
“Think about end of the year,” Nash says. “You get all kinds of requests for charities. Most people spend some day in late December trying to figure out and scramble with all of their donations. The donor-advised fund allows you to make one donation, and your tax deduction is taken care of. After that you can decide what the charities are that you would like to support.”
Many financial advisors, particularly those who offer planning services, work with clients to implement donor-advised funds. Nash says the process usually begins from a tax-planning standpoint, and is most often applied to appreciated assets, rather than cash.
“About two-thirds of the assets that we take in in a year that are not cash,” he says. “That could be appreciated securities. It could be restricted stock. It could be even the sale of a private business. If an advisor is working with a client, and there are assets that are private, like a business, and they’re thinking about retiring and selling it, that’s a great time for an advisor to say, ‘There’s a way to donate some of these shares of your private holding to a charity.'”
While the notion of charitable giving may conjure up thoughts of the wealthy looking for a tax break, Fidelity Charitable points out that donor-advised funds are appropriate vehicles for middle-class investors.
According to Fidelity Charitable data, the average grant size is $4,300. The number of grants made per giving account was 9.2, as of June 30, up from 1.9 in 1993. A donor may open an account with as little as $5,000, and the minimum grant size is only $50. Sixty-one percent of Fidelity Charitable’s giving accounts have balances under $25,000, with $15,000 as the median account balance.
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For any investor who would like to make charitable contributions and enjoy the tax benefits from qualified donations, a donor-advised fund may be worth a look.
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Is a Donor-Advised Fund Right For You? originally appeared on usnews.com
