Let’s assume you’re charitably inclined. Let’s also assume you have completed a comprehensive financial plan, and the results show that you’ll have a large sum of money at the end of your life, even if you live much longer than anticipated. Or perhaps you have received a large windfall with a corresponding large capital gains tax liability.
You agree that having this money doesn’t make much sense after you’re dead, or while alive, so you start to think about supporting a charitable cause. You pick one, or more, organizations that bring joy, care, comfort, and support in an efficacious way. So, now that you’ve chosen your charity, you take out your checkbook and write the check. You go off to bed and have a great night’s sleep, knowing you just did a great thing—and you get a nice tax break to boot.
When giving money, most of us use the charitable deduction the normal way—that is, we write a check (or checks) every year. However, perhaps we should think of our charitable contributions more strategically, especially with the new tax bill that passed in December 2017. What if you could allocate a larger amount of money earlier in your life and then distribute it as you wished each year, allowing for more freedom and flexibility for your philanthropic pursuits?
Using a donor-advised fund (DAF) can be an excellent way to give, with the bonus of being a brilliant way to offset taxes in a potentially high tax year. Here’s how a DAF works:
- You (the donor) open a DAF account and write your check to the DAF provider. The amount can be whatever you want; however, it’s usually for a larger amount than you would normally give in an average year. We’ll see why later.
- The funds are irrevocably transferred to the provider—that is, the process is like giving to any other charitable organization in that you can never get your money back once sent in.
- While you are not the owner of the DAF, you do have the power to control how much, when, and to whom you send charitable dollars. This is the big difference between the normal way of making charitable contributions and a DAF.
- One bonus about these accounts is that you can invest your contributions and earn money for the eventual recipients.
So, in carrying through with the example above, you could open and contribute to your DAF almost anytime, or in the year you plan on incurring a capital gains tax (e.g., in the same year you plan on selling stock or investment property, or receiving a windfall). Your contribution could be around the same amount you would want to bequest at the end of your life as well.
Of course, the amount should be large enough to make a difference to you tax-wise but small enough so that you’re not endangering your financial security. You could reduce your taxes, start to make contributions in smaller amounts to the organizations you want, and have the opportunity to make money in an investment portfolio as well for your favorite charitable causes!
Combined with the clarity of a good financial plan, using a DAF can be a great, long-term strategy for your personal finances and philanthropy.