As complex as you can make your finances, it comes down to two simple levers: income and spending. It’s much like trying to lose weight, where you can burn more calories or consume fewer and arrive at the same place.
With money, you can improve your situation by spending less or making more. And sometimes, upgrading your tax strategy is a great way to spend less. Depending on your income level, your taxes can take up 25% or more of your gross income.
If you decide to itemize your deductions, charitable donations come into play. For some people, utilizing donor-advised funds can upgrade your charitable contributions strategy.
Are Donor-Advised Funds a Good Option for Charitable Donations?
Are donor-advised funds a great way to make a tax-deductible donation to a charity?
That’s what a Clark Howard podcast listener recently asked.
Asked Peter in Maryland: “I would like to get your opinion on Donor-Advised Funds (DAFs). My retirement advisor recently recommended them to me as a way to reduce my long-term capital gains tax on shares of appreciated stock.
“I typically contribute around $20,000 a year to my church and other local charities and I currently have more than $100,000 in unrealized gains in my Schwab brokerage account.
“I see that there are fees associated with DAFs, but the fees are small compared to the 15% long-term capital gains tax savings. It seems like a no-brainer to me. In this case or in general, are there any reasons not to use a DAF for charitable contributions?”
A donor-advised fund involves a third-party administrator that manages charitable donations on your behalf. They offer huge tax advantages and allow you to donate tax-deductible investments to charities.
“I love donor-advised funds if you do them in the right places,” Clark says. “You donate the stock or fund to the Schwab charitable fund. Then you have an account established there. We’ll call it ‘Peter the Generous Fund.’
“And then you can recommend who you want to donate money to. In your case your church. And they validate that it’s a valid charitable organization. And then they accept your recommendation and send a check to it from you.”
Be Careful To Choose a Low-Cost Administrator for Your Donor-Advised Fund
When you deal with investing, it’s important to find a low-cost, trusted company. That’s as true for donor-advised funds as it is for any other type of investment.
“They are atrociously expensive at any bank-based donor-advised fund. Be aware unless you hate the charities you’d like to give to, never do a donor-advised fund with any bank-based or bank-affiliated brokerage,” Clark says.
“Donor-advised funds are very affordable at my three favorite children [Vanguard, Charles Schwab and Fidelity]. They’re the cheapest at Vanguard.
“You mentioned Schwab. Schwab has a very good low-cost donor-advised fund. It’s kind of like having your own micro foundation at a fraction of the cost.”
The Tax Advantages of Donor-Advised Funds
Clark is a huge fan of tax advantages whether it’s through a Roth or traditional 401(k) or IRA, a 529 plan, HSA funds or anything else.
So he delighted in explaining the tax advantages of donor-advised funds to Peter.
“You get a double benefit in that tax year,” Clark says. “You don’t pay capital gains on the gain a stock or fund may have had over decades. So you get that what’s known as step up in basis tax-free. And then you get a tax deduction on the full amount of the contribution.
“By comparison, if you sold a stock, you’d have to pay the gain on it. And if you donated it to charity, the money, the proceeds, it’s much less valuable than if you do it through the donor-advised fund.”
Final Thoughts
Clark loves donor-advised funds. If you itemize your deductions on your taxes, you have unrealized investment gains and you like to make charitable contributions, they’re a great vehicle to do so.
