What is a Donor Advised Fund? How does it work and why would you want to open one? What exactly are the tax savings? And be sure to listen to the end where I review some real-world strategies used by clients.

We cover topics such as:

  • A Donor Advised Fund is simply an account that you own.
  • How to open a Donor Advised Fund
  • How to transfer money into a DAF
  • Why most Americans do not get a tax deduction for their charitable gifting
  • How to use a “bunching” strategy.
  • How to use a DAF in high-income years such as a bonus or exercising stock options or an IPO

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Transcript
Mike: [:

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

Julie: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:

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: [:Mike: [:

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: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:

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: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:

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: [:

to have to be given away. Okay.

Mike: [:

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: [:Mike: [:

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

Julie: [:Mike: [:

. 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: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:

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: [:Mike: [:

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: [:Mike: [:Julie: [:

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: [:

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: [:Mike: [:

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: [:Mike: [:

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: [:Mike: [:

If that's something you might be interested in.

Julie: [:

the money to do it

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

Mike: [:

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: [:Mike: [:

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: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:

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