Ep 5: What is a Donor Advised Fund and why have one?

Mike: [00:00:00] Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton chartered financial counselor and financial advisor. Today, we're talking about donor advised funds. What they are, how they work and why you'd want to use it. And of course, a couple of real world examples.

Now to keep me honest with us today is my great friend, Julie. Welcome to the show Julie

Julie: [00:00:29] Thanks so much for having me.

Mike: [00:00:31] And her job is going to be to keep me honest as I'm rambling on about donor advised funds and using jargon and whatever it is, she will immediately interrupt and say, Oh wait, that didn't make any sense.

Julie: [00:00:42] as I do. in most of our conversations.

Mike: [00:00:45] that's right. That's right. Just as usual. I'm so glad you're here.

And this is going to be a great topic because donor advised funds are something that people are really not taking advantage of and it's a great tax saving tool. So let's just dive right in first. Julie, do you have a donor advised fund?

Julie: [00:01:01] I have no idea. I don't even know what it is.

Mike: [00:01:05] That's perfect. All right. A donor advised fund., we'll start at the top level. What this thing is, it's an account, right? So it's just simply an account, like a checking or savings or brokerage account, and it has to do with charitable giving. So it's a type of account that we're going to use for our charitable giving.

Now it's an account that you own. You can open one of these with a few clicks of a button. You can open it at Schwab or Fidelity or Vanguard. And there's also community-based programs where you can open these up. So it's an account, a few clicks you would open it up. And it's your account and your name. Now,

how would you use it? You can transfer money into this account, just like you would a checking or savings account. . So very easy. Do you use all online, just like you use any other account, What it is, however, is a charitable giving account, right? So why would you have one of these, one of these types of accounts versus a checking or savings account?

And because there are certain tax rules for why you would use it. So most people are not getting charitable tax deductions. All right. So if you give a thousand dollars to charity, , you should be able to get that off your taxes. That's the whole point, right? Most people, when you come to file, your taxes are not getting that deduction.

And the reason why is because if you are not above the standard deduction, it's an itemized deduction that thousand dollars. And so you won't, you won't be any use to you actually won't get it off your taxes. Does that make sense?

Julie: [00:02:44] so let me back up a little bit., we donate to a number of different organizations. Pre-tax from our paychecks. Would that, should we be doing that from the donor account instead?

Mike: [00:02:59] I'll tell you why the donor accounts useful in a minute. But before I do that, I want to back up to the charitable contributions. So if you give a charitable contributions to the red cross comes asking for money and you give them a thousand dollars, that's great that, we're, helping out other organizations and people that need money and whatever we believe in.

It would be also nice to get, a tax deduction for that the government does allow for tax deductions for that thousand dollars. So you think, Oh, this is great. You know, I'm going to give a thousand dollars to this. Charity. and are going to get a little tax break. Right.

Julie: [00:03:31] for sure. Yeah. But you are supposed to collect a receipt or some.

Mike: [00:03:36] That's right.

Julie: [00:03:37] process for, for doing it. And then if you don't remember where that is

Mike: [00:03:42] that's right.

Julie: [00:03:42] of the year,

Mike: [00:03:43] That's right.

Julie: [00:03:45] there you go,

Mike: [00:03:46] . Yup. You get the receipts because it has to be a qualified charity. You can't just give it to your brother-in-law and say, I'd like tax deduction. So has to be a qualified charity. So you get the receipt, save the receipt. When you go to file your taxes, you should get a thousand dollars off.

Right. Most people are not getting that. In fact, I'll bet you, Julie when you filed your taxes, you save those receipts and you didn't get any tax savings from that thousand dollars. All right. That's a good question. What happens is you go to fill out your taxes, say you made $150,000 last year. Okay. So that's all your wages and income.

And maybe you had some interest in dividends, from your checking and savings accounts. And so maybe that total $150,000, you get a standard deduction. If you're married, filed jointly, you get

...

$24,800 as a standard deduction. So take your 150,000 minus the 24 for, now you're left with about 125,000 of income and you owe taxes on that 125,000. Mostly you've given it , throughout the year on your paychecks, they're deducting stuff. Right. And so then you compare and say, Oh, okay. Yeah, I've already paid all my taxes. I don't actually owe anything. Come April. Perfect. Okay. Now , where was the charitable deduction in that calculation?

The problem is to get the charitable deduction, you have to itemize your taxes.

Julie: [00:05:10] that long drawn out process with the 27 extra pages.

Mike: [00:05:15] that's right. That's right. So the item itemizing your deductions, you use an accountant or their software or your software, So it asks you a bazillion questions about everything. Oh, did you go to charities? Yeah. Yeah. How much did you give those receipts? Right.

All that stuff. It asks those questions. It also asks you about your property taxes. Did you pay property taxes? And maybe that was $10,000 ,we live up in the lovely state of Massachusetts or Taxachusetts

Julie: [00:05:41] yes,

Mike: [00:05:41] some people call it

Julie: [00:05:42] plenty of taxes.

Mike: [00:05:43] plenty of taxes or property taxes, a little bit higher.

So maybe your property tax is 15,000 and then it also has, maybe you have mortgage interests. That'd be another biggie for the itemized deductions. So things are mentioned. So you maybe say, Oh, you had 8,000. Remember the mortgage company. Send you a receipt and you say, yeah, I had 8,000 of interest for my mortgage.

So you add up your property taxes, your mortgage interest, your charitable giving, plus some other line items. But those are the big ones. If that is less than $24,400. Remember the standard deduction is 24,400. If your itemized deduction is less, which would you like to deduct the 18,000 or the 24,000 from your taxes? 24. So you take the standard deduction and your charitable contribution was under the itemized deduction, which was less than the 24,000. So you don't actually get a tax break for that thousand dollars that you gave to charity. Does that make sense?

Julie: [00:06:44] . It does. How often is the standard deduction? More than an itemized deduction?

Mike: [00:06:50] Fantastic question. I'm glad you asked that because we had a recent rule change that the standard deduction doubled. Now, according to the Brookings Institute, over 90% of Americans take the standard deduction.

Julie: [00:07:06] Wow.

Mike: [00:07:08] Okay,

Julie: [00:07:09] So we're all losing our charitable contributions.

Mike: [00:07:12] Charity still gets the money. It's fantastic. You get to take a standard deduction, which is higher than it used to be. So you actually are saving more money overall, but literally that thousand dollars is not changing your tax situation.

Julie: [00:07:26] Okay. So now tell me about this donor fund. Cause I'm sensing I'm going to get a change in my taxes from that.

Mike: [00:07:33] So now we're back to the donor advised fund. Let me tell you a little bit more about how it works and then we'll round out to the tax question. So you can give money to a donor advised fund. It is kind of like your own private charitable foundation. Remember I said, you opened an account it's in your name. And you can transfer money. You could transfer $10,000 from your savings account, into your own donor advised fund. When you transfer the $10,000, on the tax situation. It's as if you gave it to a charity.

Julie: [00:08:05] Even though my fund is not a five Oh one C3

Mike: [00:08:08] that's correct. Yes. Yes. The way that, the reason why they have these now, and they're pretty recent is because.

It allows you to more easily do this as an individual, whereas before you had had to set up your own private charitable foundation. So they just said, no, we'll make it easy for individuals to do this. So even though it's not a charitable foundation, it is a donor advised fund. When you give the 10,000 into that fund, you get to on your taxes, take off $10,000 charitable contribution.

Julie: [00:08:38] What are the rules for using the fund?

Mike: [00:08:40] Ha they have to end up going to. Charitable foundations. . Eventually, but you could do it this year. You could do a next year. You could do it five years from now.

Julie: [00:08:52] So in theory, I could put. 10,000. Is there a limit to how much I can put in per year? First?

Mike: [00:08:58] I don't believe it's a good question. I don't believe that there is a limit,I'll definitely look that up and put it in the show notes, but I don't think there's a limit in a single year, how much you could give

Julie: [00:09:07] So if I were to put $10,000 in this year, $10,000 in next year and give 2000 away each year. Is it essentially just a savings account or is it like a tax shelter? I'm not, I, I'm

Mike: [00:09:22] Yup. Okay. So llet's figure out ways that we can use this good question. Like, why would I use this, ? Or what's the use? Okay. So the money goes in, you get the charitable contribution in that year on your tax returns, then you can Dole out the money. Over multiple years now, one other point, just to round out what a donor advised fund is, the money is sitting in there that $10,000.

I said, it's like a check-in savings, brokerage account. You can invest that money so you could invest it just in cash. You could invest it in bonds. You could invest it in the stock market. . So you have that capability as well,

Julie: [00:09:55] but none of those are five Oh one C3.

Mike: [00:09:57] No, but it's, remember it's in your donor advised fund that account.

It's kind of like a brokerage account. So you could take the 10,000 and say, I'm going to Dole it out over five years. I'd like it to maybe grow a little bit. So I'll invest 50% in bonds, 50% in stocks that 10,000. So hopefully it grows a little bit, so I can have more money to give away in three or four or five years from now.

Julie: [00:10:17] So you can't take the profits back

to have to be given away. Okay.

Mike: [00:10:22] that's right. So money goes in, from wherever charitable contributions, and then you have to give it out to charities. And it's a really good point. If you're going to use one of these and you have particular charities. that you support, make sure they're going to qualify from whatever custodian, like if you're open at Fidelity or Vanguard or Schwab or wherever, make sure that the charity you want to give to is going to be on their approved list.

And trust me, the approved list is really long, but , if there are particular churches or other charities that you like to give to just make sure they're on that list. Okay. So let's get to why this is useful or how to use it. The most common use. Is something that's called bunching. Okay. And this gets back to

Julie: [00:11:05] did you say lunching with the B?

Mike: [00:11:07] I said bunching with a B that's.

Right. I don't know why they named these things. This

Julie: [00:11:12] Just making sure.

Mike: [00:11:14] Yep. Just in case you want to look it up, that's what you would use. It's called like donor advised fund bunching strategy. That would be like Google term, so you can look up, exactly how this works and here's the way that here's going back to our previous example.

. Say you had in your itemized deductions, your state and local tax and your mortgage interest. I told you those are kind of the biggies say they were $18,000. Okay. For the year between those two.and then you give 5,000 to charity, all right. During the year, so straight to charity. So that's a total 23,000.

That's less than the standard. So again, that 5,000 you gave away is not helping your tax situation. All right. What if I said, , well, you have charities. You'd like to give to, and you'd give about 5,000 a year. Let's give four years' worth all this year, and then Dole out the 5,000 a year for the next five years, the next four years.

So we're going to, give $20,000 to our donor advised fund and then Dole out the 5,000. So now what is our tax situation for this year? Look like we still have the 18,000 from our state and local taxes and mortgage interest. We're adding 20,000 as a charitable contribution into our donor advised fund.

So now that's 38,000, which is above the 24,000. So we're going to be minus 38,000 off our wages and income. So we are getting a good tax deduction for this year, right. That makes sense. Yeah.

Julie: [00:12:46] It makes sense? Yes. Okay. Continue. Cause I have a, I'm assuming you're going to address my question.

Mike: [00:12:52] probably not. But the only thing I was going to say after that is, so this year we get the 38,000 off the taxes. That's great. And then the following few years, we're only at the 18, so we're not going to itemize we'll use the standard $24,000 deduction in the following three years, which is what we were going to do anyway.

Julie: [00:13:11] Okay, so this is a longterm strategy,

Mike: [00:13:15] Yes. It doesn't happen all in one year. That's correct.

Julie: [00:13:18], and you are going under the assumption that your financial situation will not change in the next three to five years.

Mike: [00:13:28] Yeah, that's true. this is a strategy that makes sense. If you have consistent charitable giving that you do with your churches, your Alma mater other organizations, or just something you believe in a certain dollar amount, a lot of people do this just based off their income. Oh, I can afford, this amount per year, my job is steady.

So we're in kind of that steady state., and so, , even at $5,000. you're not getting a tax benefit. And so, this bunching strategy as a way of saying, Oh, let's roll four or five years worth into one year to get a good tax saving. And then also we're going to get the same tax saving for the pre the next years we were going to get anyway.

Julie: [00:14:05] right. Okay. So it's sort of a savings account for. Charitable giving what is the oversight to make sure that the money in the account goes to charitable foundations, and what's to say, I don't let it grow for 20 years and keep putting money in it. What happens to that money?

Mike: [00:14:33] It can, you can have money in there for 20 years and have it keep growing. The oversight is as mentioned earlier, depending on where your custodian is for the account, they're in charge of approving your request to withdraw money and the money goes straight to wherever it is that you're giving it.

So whether it's, an Alma mater, a charity, a church. You know, you put in a request, there's usually, drop-downs like you search for your charity up. It shows up, again, there's thousands of them listed, shows up. You say, I want to give $500. They say, okay. And you hit the request button. And then about 24 hours later, it's like, Oh, approved.

And they send the check straight out.

Julie: [00:15:16] Straight to the charitable.

Mike: [00:15:17] Yeah, that's right. That's

Julie: [00:15:18] so this is really interesting because I have always had the thought to start a scholarship foundation. I benefited from scholarships in college. I'd love to pay it forward. I don't have enough to make a huge amount in any one year, but could this be a strategy to fulfill that dream of mine to just keep putting money into a donor advised fund?

And then say in 10 years, if I have a hundred thousand dollars in there, I can start a scholarship fund for whatever, go through the process. And then I can put all of that money into that fund.

Mike: [00:16:01] Yes. However, for tax purposes, if you are going to say, Oh, this is great. I want to start saving towards, a scholarship or, giving a large amount over time. That's the opposite of the tax strategy we want to do. So you'd want to save that in just your regular checking or brokerage account.

And once it grows to 10 or 20 or 30,000, you could give it all to the donor advised fund all at once. Again, to get above that standard deduction. And have it continue to grow there if it's not at the point that you're ready to give it all, as a chunk, but yes, you can use these to continue to grow money.

But my recommendation, like I said, , in that case, if it's, Oh, I'm going to do a thousand dollars a year or 5,000 a year. Well, you're not going to get above the standard deduction for a tax benefit. So why don't you just save that in external account into a grows to an amount that, ywe can do it all at once.

Julie: [00:16:56] So this is really a strategy for not really a one-time, but sort of a one-time big tax break for all of the charitable givings that you had planned to do that year in the following

Mike: [00:17:08] Yeah, if you're on a steady state, I do X number of dollars per year as my charitable giving. You might find yourself in the situation that we described at the numbers where you're below the standard deduction. So you're not getting a tax benefit. So bunch, three, four or five years worth all in one year.

And then just give it out as you have been doing . That's strategy number one. . And that's a very typical one that. Makes sense to a lot of people,there's a couple other things I do want to mention though, specifically, for entrepreneurs that might be in a different tax year, from year to year, whether it's from stock options or , companies being bought out or IPO or a bonus or something like that, there's a couple of other ways that you can use these.

So one is if you have a large income year so you've got that big bonus. Or IPO or a big stock grant and suddenly your salary is way higher. Right? So if you were making, as a family, maybe making close to 300,000, you're just about at that 32% tax bracket. So if you get a bonus of a hundred thousand,you're getting taxed at 32 cents on the dollar.

All right. So you could do a large contribution. You're not ready to give it to charity. know, you're charitable minded, but you're not ready to say, Oh, I'm giving away a hundred thousand dollars, but you know, this is a big tax year. You could give a significant portion to a donor advised fund. And that's when you're really saving tax dollars, right.

32 cents on the dollar is a lot versus your normal 20 cents on the dollar.

Julie: [00:18:35] yeah, that makes sense.

Mike: [00:18:36] , Now another thing to consider, as we were talking about just giving money.. But you can donate stock., to these donor advised funds. So you have a portfolio of stock, some of it's done really well.

Maybe you had Apple stock for the last 15 years or Amazon, and it's just gone or zoom for the last, like two months. And it's quadrupled., and so if you sell that and in a capital gains and you have to pay, 15 or 20 up to 20 or 23%, depending on your income in capital gains. So if you had a hundred thousand dollars gain in your stock, And you sell it, you pay taxes on a hundred thousand and then you give it away.

then you get the charitable deduction, but you've already paid taxes. You can donate appreciated stock and get the full contribution. So if you donate a hundred thousand dollars worth of stock, you get a hundred thousand dollar contribution. I mean, reduction in your taxes, even if there was built-in capital gains.

So you don't pay the capital gains by selling a stock first. Right? You can donate it. And the charity will not pay capital gains because they're a charity. And the same with the donor advised fund, you can gift appreciated stock to the donor advised fund. So this is another great one for entrepreneurs or tech professionals, where you have stock options, you got them really cheap companies doing great.

so all of a sudden that stock is worth a lot and you're going to pay a lot of capital gains on that. You definitely want to, if you're going to be charitable minded, donate the appreciated stock.

Julie: [00:20:02] Okay.

Mike: [00:20:03] And then the last thing I'll mention, and this is kind of interesting. One again, if you're charitable minded is maybe set yourself up for the future, if you want to be a part or a member of a charity. Okay. So you could give to a donor advised fund, your own donor advised fund, and then maybe even start your own charity five or 10 or 15 years later.

If that's something you might be interested in.

Julie: [00:20:26] and then I'd have

the money to do it

already saved. to fund the charity that you're starting.

Mike: [00:20:32] That's right. That's exactly right. So you could potentially, , depending on how you set up your charity use that donor advised fund money. And again, for entrepreneurs or anybody, that's in a situation where you might have some large bonuses or stock grants or something that's very significant for a couple of years.

You could , say, Oh, this is my might be something I want to transition to a little bit down the road. And so you could donate that appreciated stock into there and have it ready and available. If that's a route that you ended up taking.

Julie: [00:21:02] All right. That was a lot to absorb.

Mike: [00:21:06] Yeah. So definitely, a lot going on here with the donor advised fund. The first, the bunching strategy is a really good kind of everyday strategy to use charitable giving and get a tax deduction. The other strategies are definitely unique, but really valuable if you find yourself in one of those situations and trust me, I've run across clients that have saved a lot and didn't realize there was a donor advised fund.

And so I had a client that had saved 50 or 60,000 that was already earmarked for charity. And then they got a big bonus year and I was like, thank goodness you ran across me. You know, you could put this 50 or 60,000 in a donor advised fund. It was already going to charity over the next few years and save off your taxes from this big bonus that you got this year.

Julie: [00:21:53] Yeah, that's great.

Mike: [00:21:54] Yeah. So there's definitely like those other strategies really do pertain to a wide range of people out there find themselves in these situations.

Julie: [00:22:02] Yeah, that's phenomenal. Especially in tech season.

Mike: [00:22:06] Exactly. Exactly. So Julie any other questions that we didn't cover with the donor advised fund?

Julie: [00:22:12] I think that was pretty comprehensive.

Mike: [00:22:15] Cool. Well, there's definitely some great strategies really appreciate having you here. Keeping me honest and on top of ,making sure we get the right information out there

Julie: [00:22:23] Yeah, no, thank you. It was fun.

Mike: [00:22:25] cool. And we'll see you next time.

Julie: [00:22:27] All right. Have a great one.

Mike: [00:22:28] Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at . Until next time thanks for tuning in.