Photo by Katt Yukawa on Unsplash
Charitably inclined investors can provide financial support to their favorite organizations in a number of ways. With all the available options, you may be wondering what’s the best way to give.
Charitable gifts can range from a simple cash gift or check to more complicated strategies that may offer greater tax savings or other benefits that make them useful ways to give money to your church or favorite charity. Two of those strategies include Qualified Charitable Distributions and Donor Advised Funds, but what is the difference between them and when should you use one over the other?
A Donor Advised Fund (DAF) is a charitable investment account that provides a tax deduction to the donor in the amount of the gift for the fair market value of the gift. In addition to cash, donor advised funds can accept appreciated securities like stocks and mutual funds. Gifts of appreciated securities avoid capital gains taxes on the gift as well as a tax deduction for the fair market value of the security.
For example, if you gift shares of stock that you have owned for many years, you will receive a tax deduction in the amount of the fair market value of the donated stock as well as avoiding capital gains taxes on the stock.
Another benefit of the DAF is that you can distribute the fund over time. There is no requirement that distributions from the fund must be made in the same tax year the gift was made.
Of course, if you take the standard deduction when you do your taxes, a small contribution to the DAF may provide little to no additional tax benefit. The work around is to make a larger, lump sum gift to the DAF, large enough for you to itemize your tax deductions.
For example, instead of donating $500 to your church every month, it may be more tax efficient to donate a much larger lump sum (preferably of appreciated assets like stock or mutual funds) to the donor advised fund, then use the DAF to dole out money to your church in regular, monthly payments. This way, you get a larger tax deduction, avoid capital gains on appreciated assets and still meet your financial commitment to your church for the next several years.
Donor advised funds work well for making large gifts of non-IRA assets like cash, stock, mutual funds, etc. Usually, they are not appropriate for IRAs with one exception. Donor advised funds make great beneficiaries for your IRA (or at least part of it).
This is because the donor advised fund is itself a tax-deductible 501(c)3 charity. When your IRA passes via beneficiary designation to your donor advised fund, there is no tax due since 501(c)3 organizations are tax exempt. If the DAF is the sole beneficiary of your IRA, you will avoid income tax on the entire IRA balance.
Of course, everything has tradeoffs. With donor advised funds the big trade off is that you are making an irrevocable gift. You may receive statements and have control over how the fund is invested as well as what organizations receive gifts from the fund, but the money is no longer yours. You will not be able to withdraw funds from your donor advised fund for your own use.
Donor advised funds also offer little to no benefit to those who wish to make small, occasional gifts, especially if they take the standard deduction on their tax return. If the standard deduction exceeds your itemized deductions (even after counting your contributions to a donor advised fund), you will get no additional tax benefit by contributing to a donor advised fund.
Qualified Charitable Distributions or QCDs are charitable gifts made directly from your IRA to the charity of your choice. By definition, all QCDs come from an IRA and not from other qualified plans or investment accounts. QCDs can not be made to a donor advised fund or personal charitable foundation.
The benefit of a QCD is that money goes directly from your IRA to your favorite charity and is not included in your taxable income when you file your taxes. Qualified taxpayers who do not itemize their tax deductions and instead file the standard deduction will benefit from making a QCD rather than giving money from non-IRA sources.
Another benefit of Qualified Charitable Distributions is that they will count towards your IRA Required Minimum Distribution (RMD) for the year. If you have a $40,000 RMD and gift $10,000 to your church, your remaining RMD will only be $30,000. Of course, you may donate your full RMD amount to your favorite charity via the QCD if you like.
QCDs have some limitations. You must be over age 70 ½ to make a QCD and your QCD is limited to $100,000. QCDs must also be made from an IRA, not a 401(k) or other retirement plan, and the distribution must go directly to your chosen charitable organization.
For more information on donor advised funds and Qualified Charitable Distributions talk to your financial or tax advisor and check out this piece from Schwab Charitable.
To discuss any of the topics in this blog or to learn more about how we can help you Cross The Bridge To A Confident Retirement, please contact me through my web site mikebranch.net, call me directly at 651-379-3935 or email me at mpbranch@focusfinancial.com.