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Because of the new tax reform, only 10% of Americans itemized their deductions in 2018 compared to 30% in 2017. This has significantly impacted the tax benefits of charitable giving, or has it?
Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte. And today we're going to be talking about one of my favorite topics for 2019, which is donor advised funds. Donor advised funds provide a simple solution for reducing your tax bill through charitable giving. Even if you're part of that 90% that's now claiming the standard deduction. And even if you only donate a few thousand dollars per year.
I'm going to cover four things today. Number one, for the first time in history, I'm going to explain what a donor advised fund is so simply that you will be able to explain it to a six-year-old. Number two, who is the right fit for using a donor advised fund? Number three, if you are a potential candidate, what's the absolute best strategy for using one? And
And then number four, where to open a donor advised fund. And then some really important things to look out for.
We're going to be talking about a lot of tax-related things today. And I just want to remind our listeners that this is purely for educational and informational purposes only. This is not advice. It's critical that you talk to your tax preparer and trusted advisors before taking any action. For all the links and resources mentioned in this episode, visit youstaywealthy.com forward slash 50.
As mentioned at the beginning of the show, 90% or more of Americans will now be claiming the standard deduction. I just want to quickly break this down. So the rest of today's show makes perfect sense for you guys. So as you know, by now, the recent tax reform increased the standard deduction limits to $12,200 for single filers and $24,400 for married people filing jointly.
What the heck does this all mean? Sometimes when we talk about itemized deductions and standard deductions, people's eyes glaze over. So let's just break this down really simply. Let's start with itemized deductions. One of the most common itemized deductions is mortgage interest. If you own a home and you have a mortgage, you pay mortgage interest. So
Let's say in 2017, before any of this tax reform went down, you were a single person and you paid $7,000 in mortgage interest for the entire year. So not your principal payments, but just the interest on the mortgage. So you paid $7,000 in mortgage interest in the year 2017.
That year, you would have chosen to itemize your deductions because $7,000 is more than the standard deduction limits back then, which were $6,350. You would rather deduct $7,000 than $6,350 because you're going to pay less in taxes. Pretty, pretty simple.
Now, in 2019, with the standard deduction at $12,200 and your same mortgage interest of $7,000, you're going to choose to claim the standard deduction and forget about that mortgage interest paid because $12,200 is more than $7,000.
Keep in mind, mortgage interest is just one example. Other common deductions that are itemized are state and local tax paid, medical expenses, and then the big reason for today's show, charitable contributions. So you can add up all of these eligible expenses, and if they're less than the standard deduction, you would just go ahead and take the standard deduction. If they're higher than the standard deduction, then you would itemize your deductions.
Now, why does this or how does this impact charitable giving? Let's go back to our original example, but let's also assume that you're going to give $3,000 to charity this year. So if you give $3,000 to charity...
and you still have your mortgage interest paid of $7,000, then you would be taking the standard deduction because seven plus three is 10,000. So $10,000, that's less than the standard deduction of 12,200 for the year 2019.
which means you were a very, very nice, generous, awesome person that gave away $3,000, but it didn't really save you any money on your tax return. You could have kept that $3,000 in your pocket and your tax return would have looked the exact same.
Now, maybe you don't care about the tax benefit and you give money for other reasons. If so, that makes you the perfect candidate for donor advised funds. And I'm going to explain why in a moment. But first, let's just break down exactly what a donor advised fund is. And I'm just going to kind of go bullet point by bullet point here so we don't miss anything. So first and foremost, a donor advised fund is a charitable giving account that
that first you get to choose a creative fund name for. Some basic examples are like, you could name it the Smith Family Giving Fund or the Smith Foundation Account, or you could even name it something like the Stay Wealthy Podcast Fund. Once you open this account with a provider and you choose a creative name or a name that matches your charitable intentions, you have to put money in it. You have to fund it.
And here's the thing. When you fund your account, you can never take your money back out. The technical term for this is irrevocable. You're making an irrevocable contribution to your donor advised fund account. Once the money is in the donor advised fund account, you can just keep it in cash and let it sit there, or you can invest it in stocks and bonds. You have some options there of what to do while you figure out some other things.
So money is in there. You can't take it back out, but you can invest it if you'd like. The only way money is coming out of the donor advised fund is if it's directed to a nonprofit. More specifically, the nonprofit must be what's known as a 501c3.
And all you really need to know is that if you give or want to give to a legitimate nonprofit, I don't care how big or small it is, chances are it's a 501c3, but you need to contact the organization. They will have an official letter from the IRS stating that they are in fact a 501c3. So do your homework first before you start putting money in the donor advised fund. Make sure that the organizations you want to give to are 501c3s.
You can send all the money in your donor advised fund to one nonprofit, or you could split it up between a bunch of different nonprofits. There's no limit. Also, you can distribute all the money in one day or over a number of years, or you can even set up a distribution plan upon your death. When I die, I want to give, I want to split my donor advised fund 10 ways between these 10 organizations. So
In other words, you can put money in this account today, invest and grow the money over the next 30 years, and then direct it towards the nonprofit or nonprofits of your choosing.
When you fund your donor advised fund account, you have some options. You can just fund it with plain cash just from your checking or savings or investment account. You just move cash from one account to the donor advised fund, but you can also fund it with securities like stocks or bonds with privately held business interests like C Corp stock or S Corp stock, or even non publicly traded assets like real estate land, or even your favorite Bitcoin last but not least,
If you itemize your deductions, you are generally eligible for a tax deduction of up to 60% of your adjusted gross income the year that you put money in your donor advised fund.
So to recap, you put money in the donor advised fund as much or as little as you want. And don't worry, you can always add to it later. You hopefully get a tax deduction. We're going to talk about that in a minute. And then you donate the money to the nonprofit organizations of your choice over time. Maybe you donate it all tomorrow, or maybe you donate a little bit each year, or maybe you invest and grow the money and you donate it decades from now.
The hidden beauty, what I like to say, the hidden beauty of the donor advised fund truly is its flexibility. While you go and explain all of that to the six-year-old in your life, I'm going to go ahead and keep us moving here. And I want to talk about next, who is a good candidate for a donor advised fund and why? In my opinion, the perfect fit for a donor advised fund has these four characteristics. Number one, they are already charitably inclined. Tax benefit or not, they are charitably inclined right now.
Number two, they're committed to giving a set amount of money every year for the foreseeable future. So it's not just like, hey, I give a little bit here and there, but they have some sort of annual giving plan. Number three, they have a high income year where they could really benefit from some extra tax deductions. Number four, they have investments or cash saved up that they can part with without jeopardizing their retirement plan. Here's why.
Let's keep it simple and say that you are single and due to the new tax laws, you now claim the standard deduction of $12,200 because...
Your mortgage is paid off, so you don't have any mortgage interest. And the only other eligible expense that you could use to itemize your deductions is the $10,000 that you give to charity each year. However, as you guys know, you're smart, $10,000 is less than the standard deduction of $12,200. So that doesn't help you at all. You're still going to claim the standard deduction.
but you still make your donation because our Stay Wealthy listeners are super generous and kind like that. So you plan to continue giving away that $10,000 per year for let's say at least the next five years. You don't care tax benefit or not. It is your plan to give away $10,000 away each year for the next five years. So do the math with me. $10,000 for the next five years equals $50,000. Okay.
If you have $50,000 in investments or cash that you can part with today without jeopardizing your retirement plan, you could contribute that $50,000 to a donor advised fund all today. You could be eligible to now itemize your deductions this year.
Get a nice break on your tax bill and then go ahead and continue to make your annual donations at $10,000 per year until that donor advised fund is empty. Again, the beauty of the donor advised fund is its flexibility. You get this nice big tax break today by donating the $50,000 and itemizing, but then you can spread out your donations just as you were going to do anyways over the next five years.
Also, maybe a year from now or two years from now, that organization you were supporting, maybe they're doing some funny things now and you don't really want to give to them anymore. Well, you can just take a pause, let your money sit in the donor advised fund, reevaluate, decide who you want to give to next. Maybe you want to wait a while. You say, you know, I'm just going to let the money grow. And in a few years, I'll circle back to this. So you have ultimate flexibility.
Of course, we want to make sure that the tax benefits of a $50,000, you know, $50,000 is a big number. We want to make sure that the $50,000 charitable contribution really does make sense this year. So, and I'm not just saying this because it's a disclosure, but you really do need to check with your financial advisor and CPA because you want to use this strategy. You want to make sure that that $50,000 contribution is really going to all be used up. It's possible that it would be better to put
$25,000 in a donor advised fund this year and $25,000 next year. So you have to kind of work with your trusted advisors or if you're an expert at this stuff, do your own research and find that sweet spot and not just dump all this money in there today and not be able to use up the entire benefit.
And again, this strategy works really well in a year where you had a spike in income. Maybe you sold a business or a stock with a large capital gain, or maybe even did some consulting work, or you're a realtor and you sold a few houses this year, and now you're in a higher tax bracket in retirement. So high income year, and then make sure that you're finding the sweet spot for that contribution. It's possible you don't give it all today. You break it up a little bit this year and a little bit next year. So work with your trusted advisors to find that sweet spot so that you maximize the benefit.
To recap, donor advised funds are a good fit anytime there's a desire to contribute and get the tax deduction today, but make the actual grants to the charity or charities of your choosing at some later date. The whole point of a donor advised fund is to separate the timing of when the tax deduction occurs, maximize that tax benefit. So separate the timing of the tax deduction with when the charity ultimately receives the money.
If you like what you're hearing so far, and you think there's a potential fit to use a donor advised fund for your charitable giving plan, I'd like to next share the best way to use one, a strategy that I think is a way to get the most bang for your buck. And to do this, I'm going to share a real life example of a client we literally just finished helping. This client, let's just call him Jack and Jill, is currently in a high tax bracket because the husband is still working.
They don't have a mortgage. Good for them. They paid the entire mortgage off and they're currently claiming the standard deduction because the new tax laws and their eligible expenses that they could itemize are below the $24,400. So they are claiming the standard deduction. They have a taxable brokerage account, just a plain vanilla investment account with a million dollars in it. The kicker is that they have unrealized capital gains in this account of $400,000. So
Meaning if we sold all of their investments today in this account, they would pay about $80,000 in taxes. Now, we obviously wouldn't just sell all the investments in this account, but they are approaching or the husband is about to stop working and we do need to rebalance the account to get them in the right position for retirement. And rebalancing the account is going to trigger a good amount of capital gains.
What's great about Jack and Jill is that they give $10,000 to one charity here in San Diego every single year, no matter what. It's a nonprofit that does amazing work that's really just near and dear to their heart. They've also been really, really good savers and they don't need every last penny that they've accumulated. In fact, through our planning process and our discovery and conversations, we figured out that they're willing and able to part with $150,000 today to
which equals 15 years of giving to this charity based on their current intentions.
Now, a careless advisor or a do-it-yourself investor that just doesn't have all the information might just sell $150,000 of securities and contribute the proceeds to a donor advised fund. Yes, you're going to get a tax benefit when you itemize your deductions that year and make that charitable contribution or make that contribution to your donor advised fund. But you also just paid 20% in capital gains tax when you sold those securities, which is going to eat into the benefit.
A smart advisor or a do-it-yourself investor who listens to this podcast would know that you can donate appreciated securities to a donor advised fund. And that's really, really powerful.
So let's just keep this simple and say that this client we're working with, they timed Amazon stock perfectly and they made a $45,000 investment in Amazon that's now worth $150,000. That's an unrealized capital gain of $105,000. And that's a big tax bill if they just went ahead and sold their Amazon stock.
So since they're charitably inclined and they're willing and able to part with $150,000 today, they can go ahead and donate the appreciated Amazon stock to their donor advised fund and avoid paying those capital gains. Now their tax benefit is twofold. They avoided over $20,000 in capital gains tax and
And they got a nice deduction on their tax return during a high income year for this really large contribution to the donor advised fund. And this is a contribution that they were going to make anyways over the next 15 years.
Now the $150,000 is in a donor advised fund. We're keeping half the money in cash for their near term donations. So they don't want that money to fluctuate. They want to know that it's there and safe and earmarked for this organization. But then the other half, we're going to invest in stocks and bonds and try to grow these funds so that they can grant even more to their favorite charity, or maybe even multiple charities in the future. So we're going to invest in stocks and bonds and try to grow these funds so that they can grant even more to their favorite charity or maybe even multiple charities in the future.
Also, side note, money, your investments do grow tax deferred inside the donor advised fund. So you're not paying taxes on dividends and interest or capital gains once the money is inside the donor advised fund. So this is a huge win for the client that could have easily been wiped out by a few careless moves. It could have just been a win that was never even achieved because it was never brought up that you could take advantage of the donor advised fund.
Quick note, when you contribute appreciated securities, the IRS actually limits the deduction you can take that year to 30% of your adjusted gross income. Cash contributions, on the other hand, are limited to 60% of your AGI. Remember, it doesn't necessarily have to be a publicly traded stock like Amazon or even a bond. You can fund a donor advised fund with untraditional assets like real estate, land, Bitcoin, and there's a bunch more as well. And if you're
And to recap, the best bang for your buck when putting money in a donor advised fund is to contribute appreciated investments. If you have them instead of cash in your savings account or selling securities or investments first incurring capital gains and then funding the account. So if you have appreciated securities, if you think a donor advised fund might be a good fit for you, that would be something that you'll want to highly consider. Okay.
Okay, let me try to bring us home here. Let's briefly discuss where to open your donor advised fund and also some important questions to ask the provider or even your financial advisor.
The great thing about donor advised funds when compared to a private family foundation, private family foundations were really popular decades ago. But the biggest, the great thing about donor advised funds is they're really easy to access. They don't require a team of attorneys. They're typically pretty low cost and you can open them with as little as about $5,000 typically.
At my firm, we typically use Fidelity Charitable for our donor advised funds for our clients. Fidelity Charitable is an arm of Fidelity Investments, and they charge between 15 basis points and 60 basis points per year to administer the donor advised fund account. They actually call it a giving account. So they charge between 15 basis points and 60 basis points to administer the giving account.
If you invest your money inside the giving account, you will also pay the expense ratio on the funds that you buy. But if you follow Fidelity and you know them well, they have some funds that are pretty much close to free. So that's not a huge concern of mine.
And remember, you can put money in the donor advised fund today, get that nice tax break, and then you could send the funds to charity tomorrow. You don't have to just incur fees year over year over year. So Fidelity Charitable is a big one. They have a great website full of really helpful information and videos and blog posts, and I'll link to it in the show notes.
But they also publish a really informative annual report on the state of donor advice funds and charitable giving. And I'll be sure to link to the brand new 2019 report in the show notes as well. Again, youstaywealthy.com forward slash 50. But for now, here's a few fun facts. Last year, Fidelity Charitable and its 200,000 donors granted a record-breaking $5.2 billion last year to over 140,000 charities.
The median account balance is just over $17,000. And I like to highlight that because it's a reminder that you don't need millions of dollars to take advantage of them. And then lastly, the most popular charity in 2018 was Doctors Without Borders, followed by the American Red Cross and the Salvation Army. Don't worry, there are plenty of small, regional, and hyperlocal charities that benefited as well, but those were the most popular in 2018.
Not in Fidelity's report, but my favorite statistic of 2018 is that San Diego was named the most charitable city in the U.S. by charitynavigator.org, which by the way, is a great website to do research on charities that you're interested in donating to, or maybe charities that you're already donating to, charitynavigator.org. But they named San Diego as the most charitable city in the U.S. in 2018, which is really awesome.
So in addition to Fidelity, two other popular donor advised fund providers are Schwab Charitable and Vanguard Charitable. There are also local providers in major cities that you can look into that are primarily focused on giving back to your community. So if your community is really important to you and you want to give back and benefit through a donor advised fund,
search around in your community, you might have something in your backyard. For instance, in San Diego, we have the San Diego Foundation. Lastly, as a part of all your research, here are a few of my favorite questions to ask either your financial advisor or the donor advised fund provider, or you might even ask both of them this. So here's a few of them, and then I'll link to all of them in the show notes. But
A few of them, what are the fees? How long does it take to establish an account or send out grants? What's the minimum size to create an account? What are the investment options for the assets in the donor advice fund? If you plan on investing money, you want to know how the money is going to be invested. Sometimes the local donor advice fund providers invest the money for you. So it's important to understand how they're investing the money behind the scenes.
Another good question. Will the donor advised fund provider only approve grants in their local area or are there any geographic limitations? And I think a big way to overcome this is if there are already a few charities that you give to today, make sure that those charities are eligible in the donor advised fund provider that you're considering, or maybe think about some of the organizations that you want to support in the future and make sure that there's no limitations there.
Accounting Today has a great list of additional questions, which I will link to in the show notes. I don't want to put you to sleep here. Those are just some of my favorite questions. Again, show notes can be found at youstaywealthy.com forward slash 50. Thank you as always for listening today. And if you have any questions or feedback, please shoot me a note at podcast at youstaywealthy.com and I'll see you here in two weeks.
Hey, it's me again. I just wanted to say thank you one more time for listening and remind you to please, please, please leave a quick review. If you're on an iPhone, leave a quick review on iTunes. If you're enjoying the show, I'm getting great feedback from listeners just like you. And I really want to keep the momentum going. So if you have a chance on your iPhone, leave a quick review on the Apple podcast app. And thank you so much in advance for all of your help and support.
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