Tax strategies

Understanding Donor-Advised Funds and Their Benefits

In 2016, I earned my Certified Financial Planner (CFP) designation alongside my friend Peter; we both passed the exam together. Fast forward several years, and Peter’s dedication to his clients has paid off handsomely, with his income reaching $50,000 per month.

During a recent conversation about managing expenses, Peter mentioned his commitment to philanthropy, stating, “I write a $5,000 check to my church every month.”

I paused and asked, “But you don’t write a check, right? You gift stock, correct?”

Peter looked puzzled and admitted he hadn’t considered that approach.

This exchange highlights a significant opportunity for high-income earners to enhance their charitable giving strategies by donating appreciated stocks instead of cash.

Advantages of Gifting Appreciated Stocks:

  1. Avoidance of Capital Gains Tax: Donating appreciated securities held for more than a year allows donors to bypass capital gains taxes, which can be as high as 20% for long-term investments. This means the full value of the stock benefits the charity, and the donor avoids the tax liability.

  2. Charitable Deduction: Donors can claim a tax deduction equal to the fair market value of the donated stock, subject to certain income limitations. This deduction can reduce taxable income, providing further tax savings.

  3. Enhanced Impact: By donating stock instead of cash, donors may increase the amount available for charitable contributions, thereby amplifying their philanthropic impact.

Implementing a Strategic Investment Approach:

After donating appreciated stocks, high-income earners can reinvest the equivalent cash amount into their brokerage accounts using a Dollar-Cost Averaging (DCA) strategy.

Benefits of Dollar-Cost Averaging:

  • Mitigation of Market Volatility: DCA involves investing a fixed amount at regular intervals, regardless of market conditions. This approach reduces the impact of market fluctuations by spreading investments over time, potentially lowering the average cost per share.

  • Disciplined Investing: Regular investments promote discipline, removing the temptation to time the market and encouraging consistent portfolio growth.

  • Flexibility: DCA can be applied to various investment accounts, including taxable brokerage accounts, allowing for tailored investment strategies.

Practical Steps:

  1. Identify Appreciated Stocks: Review your portfolio to determine which stocks have appreciated and are suitable for donation.

  2. Transfer to Charity: Work with your financial advisor or brokerage to transfer the stocks directly to the charitable organization, ensuring compliance with IRS regulations.

  3. Reinvest Using DCA: Allocate the equivalent cash amount into your brokerage account, setting up automatic, regular investments to implement the DCA strategy.

Considerations:

  • Tax Regulations: Be aware of IRS rules regarding charitable deductions and capital gains to ensure compliance and maximize benefits.

  • Recipient’s Tax Implications: If gifting stocks to individuals, understand that the recipient inherits your cost basis and may be subject to capital gains tax upon selling the asset.

  • Professional Advice: Consult with a financial advisor or tax professional to tailor this strategy to your specific financial situation and goals.

By shifting from cash donations to gifting appreciated stocks and reinvesting through dollar-cost averaging, high-income earners can enhance their charitable impact, achieve tax efficiencies, and maintain a disciplined investment approach.

 

""The proof of love is in the works. Where love exists, it works great things."
– St. Gregory the Great

-Aristotle

Having an honest, trusted, and knowledgeable advisor who can help you make smart decisions and create a path to your financial goals is the best way to secure your future and the future of those you care about.