If you like to donate money to charity and you have investments, you should highly consider a donor-advised fund (I’m not a financial expert, and this is not financial advice).
I wish I had found out earlier about the benefits of one.
What is a donor-advised fund?
A donor-advised fund is an investment account that becomes separate from your finances but which you have full control over for charitable giving.
Why use a donor-advised fund?
If you have investments, a donor-advised fund has the potential to save you a lot of money. The amount will depend on how appreciated your assets are and how much you give to charity. If your assets have appreciated a lot and you give a lot to charity, you stand to save a lot of money on taxes. You could also just take all that money that you’re saving on taxes and give it to charities, so either you are getting more money or the charities are getting more money — only the government is missing out.
How do you use a donor-advised fund?
We’re going to use hypothetical numbers to illustrate.
Suppose you have $10,000 in an investment account and only hold stocks, and those stocks don’t pay dividends (we’re simplifying things to make the point). Suppose that $10,000 is comprised of a $3,000 principal (the amount of money you have actually put in) and $7,000 in gains (how much the stocks have risen in value).
So, if you sold all the stocks in that investment account, you would get $10,000, you wouldn’t pay any taxes on the $3,000 principal, but you’d pay taxes on the $7,000 in appreciation (since that’s income).
Ignoring any tax brackets, let’s also put the long-term capital gains tax at 15%, so you’re going to owe 15% of that $7,000 in income, i.e. you’re going to owe the government $1,050.
Unless you had used a donor-advised fund.
If you would have donated $10,000 at some point, then you can use a donor-advised fund to entirely wipe out that tax bill (the donations don’t have to be all at once; you can do them gradually, but I’m giving the example as an all at once donation for the sake of simplicity).
To wipe out that tax bill, you take that $10,000 donation and buy stocks (it can literally be the exact same stocks that you already own and in the same proportions). Because you’re buying those stocks at the present value that they are at ($10,000), then 100% of that $10,000 investment is principal (the amount that you put in) and 0% of it is appreciation (since it hasn’t had time to grow yet).
You then take the original $10,000 from that investment account and donate it to your donor-advised fund. The second you donate it, it doesn’t belong to you anymore, the entire $10,000 is tax deductible (just like if you had donated it directly to the charity), and you pay $0 in income taxes — even though $7,000 of that $10,000 was appreciation/income.
What you’ve done is swapped out $10,000 in stocks you will owe taxes on when you sell them with $10,000 in stocks you will owe no taxes on when you sell them.
Whether or not you understood everything about the preceding, here are the different outcomes.
Without a donor-advised fund:
- $10,000 in an investment account.
- $1,050 in taxes if you sell those investments.
- A $10,000 donation that you can deduct from your taxes.
With a donor-advised fund:
- $10,000 in an investment account.
- $0 in taxes if you sell those investments.
- A $10,000 donation that you can deduct from your taxes.
Over a person’s lifetime, if they have significant investments and significant donations, then they can end up saving themselves and/or giving to charity much more money than if they had been directly donating to the charities.