Using a donor-advised fund to minimize taxes

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willthrill81
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Using a donor-advised fund to minimize taxes

Post by willthrill81 »

In about three years, we will be able to max out my HSA (already done), 401k out work (contributing 7.5% currently, which is matched 100%), my wife's traditional and/or Roth IRA, and my Roth IRA (I'm not eligible for deducting TIRA contributions but my wife is) and still have some additional funds to invest, likely around 5-7% of my net pay. We're in the low end of the 25% tax bracket and will likely be so even after maxing out our tax deferred accounts. Until recently, I've just thought that we would invest the rest in a taxable account. During retirement, we will likely be in the 15% bracket unless the market treats us very well indeed. My plan is to likely use Roth money if we would otherwise be bumped into the 25% bracket during retirement.

But I've recently had a thought. We give a certain percentage of our take home income to various charities and plan to continue to do so indefinitely. My thought is that whatever money we have that would otherwise be going to a taxable account should instead go to a donor-advised fund (DAF). This will enable us to take the deduction while we're in the 25% bracket rather than the 15% bracket during retirement. During retirement, we'll be able to route as much as we want to various charities, based on our take home income (or more, depending on the performance of the DAF).

Further, this might enable us to effectively stay in the 15% bracket for much or even all of the rest of my working career, in which case I'll max out both my wife's and my Roth IRAs.

It's true that if we will be keeping our income at the top of the 15% bracket during retirement that we could withdraw whatever funds we wished to donate and effectively still get a 25% tax break. But in the event that we're unable or unwilling to withdraw enough to stay at the top of the 15% bracket, going the DAF route would be preferable. However, if we were in this case (at the top of the 15% bracket during retirement), being stuck paying the .6% annual DAF administrative fee unnecessarily might make this less preferable, but I still think the DAF approach would be at least a wash due to the tax drag on the taxable account as long we have funds there. So I see this strategy as being significantly better or just a wash at worst.

It would take us a couple of years to save up enough to meet Vanguard's $25k initial startup balance, but I don't see that as a big problem.

Thoughts on this strategy?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
mayhapbh
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Re: Using a donor-advised fund to minimize taxes

Post by mayhapbh »

willthrill81 wrote:We give a certain percentage of our take home income to various charities and plan to continue to do so indefinitely. My thought is that whatever money we have that would otherwise be going to a taxable account should instead go to a donor-advised fund (DAF). This will enable us to take the deduction while we're in the 25% bracket rather than the 15% bracket during retirement.


Have you compared the present value of the larger contributions you might make if you pursue this strategy ("whatever money") with the present value of your expected future contributions if you do not ("a certain percentage")? You may save on taxes, but end up with less money in the end. That's not necessarily a bad thing -- donating more to charity means having less for yourself, all else equal -- but if a big reason you're considering this plan is to save money (via tax savings), you should consider whether you might end up giving away a lot more than you planned. $1,000 today (with years of future compounding to come) can be worth a lot more than $1,000 in retirement, tax savings notwithstanding.
willthrill81 wrote:It would take us a couple of years to save up enough to meet Vanguard's $25k initial startup balance, but I don't see that as a big problem.
For what it's worth, other entities have a lower initial startup balance: https://www.bogleheads.org/wiki/Donor_a ... e_examples
This post is not advice of any kind -- legal, financial, etc. -- and you should not rely on it.
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Re: Using a donor-advised fund to minimize taxes

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willthrill81 wrote:In about three years, we will be able to max out my HSA (already done), 401k out work (contributing 7.5% currently, which is matched 100%), my wife's traditional and/or Roth IRA, and my Roth IRA (I'm not eligible for deducting TIRA contributions but my wife is) and still have some additional funds to invest, likely around 5-7% of my net pay. We're in the low end of the 25% tax bracket and will likely be so even after maxing out our tax deferred accounts. Until recently, I've just thought that we would invest the rest in a taxable account. During retirement, we will likely be in the 15% bracket unless the market treats us very well indeed. My plan is to likely use Roth money if we would otherwise be bumped into the 25% bracket during retirement.
But I've recently had a thought. We give a certain percentage of our take home income to various charities and plan to continue to do so indefinitely. My thought is that whatever money we have that would otherwise be going to a taxable account should instead go to a donor-advised fund (DAF). This will enable us to take the deduction while we're in the 25% bracket rather than the 15% bracket during retirement. During retirement, we'll be able to route as much as we want to various charities, based on our take home income (or more, depending on the performance of the DAF).
Further, this might enable us to effectively stay in the 15% bracket for much or even all of the rest of my working career, in which case I'll max out both my wife's and my Roth IRAs.
It's true that if we will be keeping our income at the top of the 15% bracket during retirement that we could withdraw whatever funds we wished to donate and effectively still get a 25% tax break. But in the event that we're unable or unwilling to withdraw enough to stay at the top of the 15% bracket, going the DAF route would be preferable. However, if we were in this case (at the top of the 15% bracket during retirement), being stuck paying the .6% annual DAF administrative fee unnecessarily might make this less preferable, but I still think the DAF approach would be at least a wash due to the tax drag on the taxable account as long we have funds there. So I see this strategy as being significantly better or just a wash at worst.
It would take us a couple of years to save up enough to meet Vanguard's $25k initial startup balance, but I don't see that as a big problem.
Thoughts on this strategy?
Could depend on a few other details, but makes sense as you outlined.

We have the Fidelity DAF - lower initial "donation" requirement and lower "grant" amounts than Vanguard.

There are several other advantages to using a DAF:

1. Can make "anonymous" grants to charities (can keep you off junk mail lists)

2. Can "time" grants for the optimum benefit of the charity when that timing differs from your donation timing.

3. Many fine organizations are not good at spreading large lump sum donations over time
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Re: Using a donor-advised fund to minimize taxes

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I have a DAF but I wouldn't use it as my preferred savings vehicle over a taxable account. You end up with a lower deduction overall over time relative to the charity you give (since the growth will be post-deduction) and I think you get more bang for you buck using taxable investments as the mechanism for funding it a few years of desired charitable gifts at a time - wait until your taxable investments have decent unrealized gains and donate those, you get to deduct the value of the growth and avoid capital gains tax. Unless you are only a few years from retirement you will have plenty of time to be making those deductions at 25%.

Edit: I also use Fidelity for it and have had no issues with them - for what that is worth.
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Re: Using a donor-advised fund to minimize taxes

Post by sport »

Keep in mind that once you reach age 70.5, QCDs may become your preferred method of making donations.
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Re: Using a donor-advised fund to minimize taxes

Post by Peter Foley »

We use a Schwab DAF, again, because of lower minimums.

The way you stated your strategy, perhaps not the way you will actually use it, was slightly flawed. You would want to invest funds in your taxable account and buy new shares and donate appreciated shares of whatever you hold with a significant gain into your DAF. By taking this approach you slowly increase the cost basis of your holdings in your taxable account.
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Re: Using a donor-advised fund to minimize taxes

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mayhapbh wrote:Have you compared the present value of the larger contributions you might make if you pursue this strategy ("whatever money") with the present value of your expected future contributions if you do not ("a certain percentage")? You may save on taxes, but end up with less money in the end. That's not necessarily a bad thing -- donating more to charity means having less for yourself, all else equal -- but if a big reason you're considering this plan is to save money (via tax savings), you should consider whether you might end up giving away a lot more than you planned. $1,000 today (with years of future compounding to come) can be worth a lot more than $1,000 in retirement, tax savings notwithstanding.
The money will grow in the DAF since it will be invested in a very similar AA to my own retirement portfolio.
dm200 wrote:Could depend on a few other details, but makes sense as you outlined.
Glad to hear it.
dm200 wrote:We have the Fidelity DAF - lower initial "donation" requirement and lower "grant" amounts than Vanguard.
Thanks for the Fidelity recommendation. I'll check them out.
avalpert wrote:I have a DAF but I wouldn't use it as my preferred savings vehicle over a taxable account. You end up with a lower deduction overall over time relative to the charity you give (since the growth will be post-deduction) and I think you get more bang for you buck using taxable investments as the mechanism for funding it a few years of desired charitable gifts at a time - wait until your taxable investments have decent unrealized gains and donate those, you get to deduct the value of the growth and avoid capital gains tax. Unless you are only a few years from retirement you will have plenty of time to be making those deductions at 25%.
I'm not sure, but it sounds like you're basically saying that it's better to pay 25% taxes on the front-end, then let the money grow in taxable, then donate it all so I'll have more to deduct later on, preferably when I'm still in the 25% bracket, either pre- or post-retirement. Is that correct?
avalpert wrote:Edit: I also use Fidelity for it and have had no issues with them - for what that is worth.
Thanks for the recommendation.
Peter Foley wrote:We use a Schwab DAF, again, because of lower minimums.
Thanks for the recommendation.
Peter Foley wrote:The way you stated your strategy, perhaps not the way you will actually use it, was slightly flawed. You would want to invest funds in your taxable account and buy new shares and donate appreciated shares of whatever you hold with a significant gain into your DAF. By taking this approach you slowly increase the cost basis of your holdings in your taxable account.
It sounds like you're recommending the same thing as avalpert did above. I hadn't considered that donating the appreciated value would be more advantageous than just taking the 25% deduction right now. And when I do make that donation, it would obviously go into a DAF so I could spread out over time how much the various charities receive.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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willthrill81 wrote:
avalpert wrote:I have a DAF but I wouldn't use it as my preferred savings vehicle over a taxable account. You end up with a lower deduction overall over time relative to the charity you give (since the growth will be post-deduction) and I think you get more bang for you buck using taxable investments as the mechanism for funding it a few years of desired charitable gifts at a time - wait until your taxable investments have decent unrealized gains and donate those, you get to deduct the value of the growth and avoid capital gains tax. Unless you are only a few years from retirement you will have plenty of time to be making those deductions at 25%.
I'm not sure, but it sounds like you're basically saying that it's better to pay 25% taxes on the front-end, then let the money grow in taxable, then donate it all so I'll have more to deduct later on, preferably when I'm still in the 25% bracket, either pre- or post-retirement. Is that correct?
Basically, that assumes you would be itemizing deduction anyway and that you won't be hitting up against the deduction limits. You also will want to retain the option to use an appreciated asset (be it a stock, real estate or something else) for charitable deduction even where it exceeds what you want to give to any one charity - DAFs are great for that.
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Re: Using a donor-advised fund to minimize taxes

Post by aristotelian »

It is possible that you could end up in the 15% bracket in retirement because of your generosity. In general, I would fund yourself first.

That said, we do have a DAF to get more bang for our charitable buck. Instead of donating cash, we donate appreciated shares and get the double tax benefit of the deduction on our AGI and avoid the capital gain. It is good when you already have plans to make significant donations and you want to do it in the most tax efficient way.

I am not clear - are you maxing the 401k?
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Re: Using a donor-advised fund to minimize taxes

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avalpert wrote:
willthrill81 wrote:
avalpert wrote:I have a DAF but I wouldn't use it as my preferred savings vehicle over a taxable account. You end up with a lower deduction overall over time relative to the charity you give (since the growth will be post-deduction) and I think you get more bang for you buck using taxable investments as the mechanism for funding it a few years of desired charitable gifts at a time - wait until your taxable investments have decent unrealized gains and donate those, you get to deduct the value of the growth and avoid capital gains tax. Unless you are only a few years from retirement you will have plenty of time to be making those deductions at 25%.
I'm not sure, but it sounds like you're basically saying that it's better to pay 25% taxes on the front-end, then let the money grow in taxable, then donate it all so I'll have more to deduct later on, preferably when I'm still in the 25% bracket, either pre- or post-retirement. Is that correct?
Basically, that assumes you would be itemizing deduction anyway and that you won't be hitting up against the deduction limits. You also will want to retain the option to use an appreciated asset (be it a stock, real estate or something else) for charitable deduction even where it exceeds what you want to give to any one charity - DAFs are great for that.
That makes sense. Thank you.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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You know if you prefer Vanguard, you can always start at Schwab or Fidelity and donate from one DAF to another. All seem to be a little inefficient at around 0.6 vs around 0.1 EF in taxable. Not as bad as some 401k plans, but still a significant drag over decades. I'd use taxable and delay donating as long as practical. This retains flexibility, reduces fees, and increases tax benefits. Still, you've got to plan for when your higher tax rate expires and may be limited to how much you can donate in the last years, so plan accordingly.
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Re: Using a donor-advised fund to minimize taxes

Post by mayhapbh »

willthrill81 wrote:
mayhapbh wrote:Have you compared the present value of the larger contributions you might make if you pursue this strategy ("whatever money") with the present value of your expected future contributions if you do not ("a certain percentage")? You may save on taxes, but end up with less money in the end. That's not necessarily a bad thing -- donating more to charity means having less for yourself, all else equal -- but if a big reason you're considering this plan is to save money (via tax savings), you should consider whether you might end up giving away a lot more than you planned. $1,000 today (with years of future compounding to come) can be worth a lot more than $1,000 in retirement, tax savings notwithstanding.
The money will grow in the DAF since it will be invested in a very similar AA to my own retirement portfolio.
Yes, I understand. I was wondering about the possibility that shifting from your current plan ("a certain percentage") to your contemplated plan ("whatever money") would mean contributing significantly more money now than you would otherwise -- and thus, potentially, donating significantly more to charity than you otherwise would. Again, not a bad thing, but a relevant consideration if saving money (via tax savings) is a big factor in your analysis.

For example, suppose you want to donate money over the next 20 years. You could donate $10 at the start of every year, with a total donation of $200. Or you could donate $200 at the start of the first year. Same total donation ($200), but very different cost to you: By donating everything in the first year, you've not only donated the $200, but also all growth attributable to the $200. If you spread out your donations, by contrast, you're giving up $10 (+ 20 yrs growth), $20 (+ 19 yrs growth), etc.

In short, front-loading contributions may save you money on taxes, but the savings could be offset (or perhaps even overwhelmed) by the loss of growth in your account. Growth in the DAF means you might be able to limit future contributions to charity, and perhaps, by reducing contributions at a precise time in the future, end up coming out ahead. But there's likely a difference between (i) doing the math and scaling back when you've effectively contributed all you otherwise would (accounting for growth/fees) and (ii) just donating everything you would put in taxable until you retire.
This post is not advice of any kind -- legal, financial, etc. -- and you should not rely on it.
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Re: Using a donor-advised fund to minimize taxes

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aristotelian wrote:It is possible that you could end up in the 15% bracket in retirement because of your generosity.
If so, so be it. I have been very blessed and want to do what I can to help others around me. Not that it's particularly important to me, but the top of the 15% bracket would still leave us with around $90k of annual spending besides what we take from the Roth IRAs. That should be enough for anyone living in at least a moderate cost of living area to live a fully and happy retirement IMHO.
aristotelian wrote:I am not clear - are you maxing the 401k?
Not currently. Due to multiple factors, not the least of which being the desire of my DW, we are working to pay off our mortgage right now. When it's done, we'll be maxing out all available tax advantaged space and should have a little that could go into either taxable accounts and/or a DAF. It sounds like just saving it in taxable accounts for a while will be best, and we can evaluate later on whether and when to start making donations to a DAF to bring us down to the 15% bracket towards the end of my working career.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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inbox788 wrote:You know if you prefer Vanguard, you can always start at Schwab or Fidelity and donate from one DAF to another. All seem to be a little inefficient at around 0.6 vs around 0.1 EF in taxable. Not as bad as some 401k plans, but still a significant drag over decades. I'd use taxable and delay donating as long as practical. This retains flexibility, reduces fees, and increases tax benefits. Still, you've got to plan for when your higher tax rate expires and may be limited to how much you can donate in the last years, so plan accordingly.
Those are my thoughts currently as well. During the last 5-10 years of my working career, strategically making DAF donations of appreciated securities to bring us down to the 15% bracket sounds close to optimal.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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mayhapbh wrote:
willthrill81 wrote:The money will grow in the DAF since it will be invested in a very similar AA to my own retirement portfolio.
Yes, I understand. I was wondering about the possibility that shifting from your current plan ("a certain percentage") to your contemplated plan ("whatever money") would mean contributing significantly more money now than you would otherwise -- and thus, potentially, donating significantly more to charity than you otherwise would. Again, not a bad thing, but a relevant consideration if saving money (via tax savings) is a big factor in your analysis.

For example, suppose you want to donate money over the next 20 years. You could donate $10 at the start of every year, with a total donation of $200. Or you could donate $200 at the start of the first year. Same total donation ($200), but very different cost to you: By donating everything in the first year, you've not only donated the $200, but also all growth attributable to the $200. If you spread out your donations, by contrast, you're giving up $10 (+ 20 yrs growth), $20 (+ 19 yrs growth), etc.

In short, front-loading contributions may save you money on taxes, but the savings could be offset (or perhaps even overwhelmed) by the loss of growth in your account. Growth in the DAF means you might be able to limit future contributions to charity, and perhaps, by reducing contributions at a precise time in the future, end up coming out ahead. But there's likely a difference between (i) doing the math and scaling back when you've effectively contributed all you otherwise would (accounting for growth/fees) and (ii) just donating everything you would put in taxable until you retire.
I'm determined to not stop contributing my determined percentage of income to charities now, so that's not an option for me.

The charities will receive the same money in either case. I will only 'release' the money to the charities, whether it comes from a direct donation by me or from a DAF, in proportion to my annual income since that is my desired method of determining how much to donate.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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Re: Using a donor-advised fund to minimize taxes

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letsgobobby wrote:
PS
(Yes, there are a few special circumstances where lump summing large contributions to a DAF years in advance can make sense. If one is going from a very high tax bracket, ie 35%+ to a very low tax bracket, ie 15% or less, there is an arbitrage opportunity as you point out. The arbitrage is particularly worthwhile if the money will be distributed over a relatively short period of time. But 25% to 15% doesn't move me as a big enough opportunity, not given the 0.6% annual drag and the loss of future deductions. Another opportunity to lump sum favorably is when a donor only itemizes in some years but not others. In that case take several years of donations in one year, itemize that year, and take the standard deduction in the other years. This maximizes total deductions.)
Another special circumstance, which applied to my mother, is that she had highly appreciated shares in a company that was about to be bought out by a private equity firm for cash. Therefore, she was about to lose the opportunity to donate the appreciated shares to charity (and incur a large realized capital gain), but she wasn't ready to decide how to distribute the money among charities. The DAF allowed her to make the donation and then figure out how to give the money away.

This isn't the OP's issue, I think, but other readers of the thread might run into this.
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Re: Using a donor-advised fund to minimize taxes

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sport wrote:Keep in mind that once you reach age 70.5, QCDs may become your preferred method of making donations.
Don't forget that at age 70.5+, you can use qualified charitable distributions up to 100k/year from your traditional IRA to give to charity with no tax on that IRA distribution. Using this for a part or all of your RMD means you don't add to AGI or taxes from the part of RMDs used for QCDs. This is pretty much a wash for most of those who itemize, but with no mortgage you may not itemize anyway, but you still get to benefit tax-wise from your charitable donations. Sometimes a lower AGI is also beneficial, such as if SS is not fully taxed.
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Re: Using a donor-advised fund to minimize taxes

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letsgobobby wrote:Without detailed analysis, my gut feeling is that you've combined a number of sensible steps but ended up with a chimera that is less than the sum of its parts.

Keep in mind that donating to a charity to reduce taxes may reduce your taxes, but it doesn't increase your wealth. Again, as I noted above, I'm merely trying to determine the most tax efficient way to donate my desired assets to my desired charities.

First determine how much you want to donate to charity. Then optimize how to do that.

The downsides to your approach have been identified but just to reiterate:

1. You will pay 0.6% or more annually above and beyond the underlying fund expenses for the privilege of carrying money in a DAF. This is roughly equal to or sometimes greater than the tax drag if you just kept the funds in taxable accounts (depending on your tax bracket). If you get into the 15% tax bracket then LTCG and qualified dividends are taxed at 0%, which means you have zero tax drag. I'll remain in the 25%
bracket until I retire, apart from perhaps a few years near the end of my career when I donate enough from my taxable accounts to bring me down to the 15% bracket.


2. You will lose the ability to deduct the higher, appreciated values that the shares in the DAF will likely reach over time. If you donate $1000 today and deduct $1000 from your taxes it's worth $250 to you. If that $1000 grows to $2000 over time, you never get to deduct any more from your taxes. In contrast if you allowed that $1000 to grow in your taxable account and then donated when it reached $2000 it's worth $500 to you. That's a big difference. I understand that well now.

The unusual twist to your plan is getting yourself into a low enough tax bracket to make some Roth conversions worthwhile. That's a neat twist, but you don't need a DAF to do it. If your usual annual donations lower your taxable income sufficiently then you can convert to Roths with or without the DAF. My usual donations are not adequate to bring me down to the 15% bracket.

The DAF is a neat marketing ploy by Vanguard, Schwab, and the like. They get to charge us a premium of 0.6% for money that once upon a time we would have simply donated to a charity directly. And they make us all feel like mini-tycoons when we watch our charitable gift funds get bigger and bigger.

Instead, the wiser strategy is to launder annual donations through a DAF simply for the benefit of record-keeping simplification and the ability to donate appreciated shares to small charities that otherwise might not be able to handle them. Letting money sit in a DAF for years essentially robs the donor of potential tax deductions in the future.Got it.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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Re: Using a donor-advised fund to minimize taxes

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letsgobobby wrote:Given your responses, I don't see any advantage to the method you propose.
Given your next paragraph, I don't understand this statement.
letsgobobby wrote:Late in your career, it could make sense to lump sum a few years worth of charitable donations to arbitrage the difference in tax rates over a short and defined (rather than long and undefined) period of time, while moving you into the 15% tax bracket and opening up tax gain harvesting or Roth conversion possibilities. In my own case I have considered whether making, say, ten years' worth of charitable donations in my final year of full time work (which ideally would coincide with the last year in which my other itemized deductions - mortgage interest, state taxes, property taxes, etc - would surpass the standard deduction) could get me into a significanty lower tax bracket one year earlier and thus allow an additional year of Roth conversions, tax-gain harvesting, or even EE bond redemption at lower or zero tax rates (if used for higher education).
This is pretty much the same plan I now have as well. However, if the market treats my retirement accounts better than I'm planning for them to, I could well end up in the 25% bracket in retirement, making the whole point of this exercise moot. When I'm around five years from retirement, I'll know far more about my account balances and will be better able to optimize my donations.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

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Re: Using a donor-advised fund to minimize taxes

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BL wrote:
sport wrote:Keep in mind that once you reach age 70.5, QCDs may become your preferred method of making donations.
Don't forget that at age 70.5+, you can use qualified charitable distributions up to 100k/year from your traditional IRA to give to charity with no tax on that IRA distribution. Using this for a part or all of your RMD means you don't add to AGI or taxes from the part of RMDs used for QCDs. This is pretty much a wash for most of those who itemize, but with no mortgage you may not itemize anyway, but you still get to benefit tax-wise from your charitable donations. Sometimes a lower AGI is also beneficial, such as if SS is not fully taxed.
At least in my state, a QCD is better than an itemized deduction. QCDs come off my state taxable income. Itemized deductions do not. The reason for this is that my state income tax is based off federal taxable income. Deductions are subtracted later on the federal form.
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Re: Using a donor-advised fund to minimize taxes

Post by grabiner »

sport wrote:
BL wrote:
sport wrote:Keep in mind that once you reach age 70.5, QCDs may become your preferred method of making donations.
Don't forget that at age 70.5+, you can use qualified charitable distributions up to 100k/year from your traditional IRA to give to charity with no tax on that IRA distribution. Using this for a part or all of your RMD means you don't add to AGI or taxes from the part of RMDs used for QCDs. This is pretty much a wash for most of those who itemize, but with no mortgage you may not itemize anyway, but you still get to benefit tax-wise from your charitable donations. Sometimes a lower AGI is also beneficial, such as if SS is not fully taxed.
At least in my state, a QCD is better than an itemized deduction. QCDs come off my state taxable income. Itemized deductions do not. The reason for this is that my state income tax is based off federal taxable income. Deductions are subtracted later on the federal form.
It's also better on your federal return, and not just for Social Security as mentioned above. The QCD doesn't count as adjusted gross income, and thus doesn't affect AGI-based tax issues, such as the Income-Related Monthly Adjustment Amount for Medicare Part B, or the deductibility of medical expenses over 7.5% of AGI.
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Re: Using a donor-advised fund to minimize taxes

Post by willthrill81 »

letsgobobby wrote: Sun Aug 06, 2017 10:31 am
willthrill81 wrote:
letsgobobby wrote:Given your responses, I don't see any advantage to the method you propose.
Given your next paragraph, I don't understand this statement.
letsgobobby wrote:Late in your career, it could make sense to lump sum a few years worth of charitable donations to arbitrage the difference in tax rates over a short and defined (rather than long and undefined) period of time, while moving you into the 15% tax bracket and opening up tax gain harvesting or Roth conversion possibilities. In my own case I have considered whether making, say, ten years' worth of charitable donations in my final year of full time work (which ideally would coincide with the last year in which my other itemized deductions - mortgage interest, state taxes, property taxes, etc - would surpass the standard deduction) could get me into a significanty lower tax bracket one year earlier and thus allow an additional year of Roth conversions, tax-gain harvesting, or even EE bond redemption at lower or zero tax rates (if used for higher education).
It's simple. The costs now are too high because the likely missed gains (and thus deductions) are too great and not offset by the 10% absolute reduction in tax rates. Over a shorter and more defined period of time, or if the tax savings are greater (20% or 25% rather than 10%) the approach can be sensible. You didn't say exactly how close to retirement you are; I presumed "not close" based on the tenor of this thread and other of your posts.
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50

So as long as the tax brackets are the same (very important), there is no difference between donating to a DAF now or in the future.

Where the DAF can be useful, as you note, is to take advantage of tax arbitrage in the latter phase of one's working career. It's better to donate to a DAF while in the 25% tax bracket if I know that I'll be in the 15% bracket while in retirement.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

Post by PhysicianOnFIRE »

willthrill81 wrote: Sun Nov 19, 2017 10:47 pm
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50

So as long as the tax brackets are the same (very important), there is no difference between donating to a DAF now or in the future.

Where the DAF can be useful, as you note, a DAF can help one take advantage of tax arbitrage in the latter phase of one's working career. It's better to donate to a DAF while in the 25% tax bracket if I know that I'll be in the 15% bracket while in retirement.
Excellent point, @willthrill81. You laid it out better than I could.

I believe the discussion you refer to took place in the comments section on the DAF post on WCI yesterday. I'm happy to see you furthering the discussion here.

I'm fairly certain my marginal tax bracket will be dropping in the next couple of years, so I have been adding to my DAF(s) aggressively to have them funded up to 10% of the value of my own retirement funds. I don't tithe, but I do believe in sharing some wealth, and the DAF is the best tool I've found to make it easier. In addition to the tax benefits, the ease of making multiple and recurring grants from them adds substantial value.

:beer
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Re: Using a donor-advised fund to minimize taxes

Post by willthrill81 »

PhysicianOnFIRE wrote: Sun Nov 19, 2017 11:19 pm
willthrill81 wrote: Sun Nov 19, 2017 10:47 pm
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50

So as long as the tax brackets are the same (very important), there is no difference between donating to a DAF now or in the future.

Where the DAF can be useful, as you note, a DAF can help one take advantage of tax arbitrage in the latter phase of one's working career. It's better to donate to a DAF while in the 25% tax bracket if I know that I'll be in the 15% bracket while in retirement.
Excellent point, @willthrill81. You laid it out better than I could.

I believe the discussion you refer to took place in the comments section on the DAF post on WCI yesterday. I'm happy to see you furthering the discussion here.

I'm fairly certain my marginal tax bracket will be dropping in the next couple of years, so I have been adding to my DAF(s) aggressively to have them funded up to 10% of the value of my own retirement funds. I don't tithe, but I do believe in sharing some wealth, and the DAF is the best tool I've found to make it easier. In addition to the tax benefits, the ease of making multiple and recurring grants from them adds substantial value.

:beer
-PoF
Thanks! Your post and response to comments were excellent as well. :sharebeer

Interestingly, I see similarities now with the tax deferred vs. Roth issue and whether one should donate to a DAF now or later. The question of tax deferred vs. Roth largely, though not entirely, comes down to one's tax brackets when contributions and withdrawals are made. Similarly to a tax deferred account, donating to a DAF is beneficial when tax brackets are higher than they would be with the money will actually be given to your charity of choice.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

Post by scotthal »

Oddly, the marginal tax rate (& thereby the DAF tax savings) tends to be higher for bogleheads in the 15% bracket than those in the 25% bracket.
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Re: Using a donor-advised fund to minimize taxes

Post by willthrill81 »

scotthal wrote: Mon Nov 20, 2017 4:04 pm Oddly, the marginal tax rate (& thereby the DAF tax savings) tends to be higher for bogleheads in the 15% bracket than those in the 25% bracket.
How can a marginal tax rate be higher for those in the 15% bracket than those in the 25% bracket? :confused
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

Post by FIREchief »

willthrill81 wrote: Sun Nov 19, 2017 10:47 pm
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50
What if you are certain that you can deduct the full amount of the DAF contribution this year, but realize that you might not be able to deduct the full amount (or any) in future years?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.
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Re: Using a donor-advised fund to minimize taxes

Post by willthrill81 »

FIREchief wrote: Mon Nov 20, 2017 5:05 pm
willthrill81 wrote: Sun Nov 19, 2017 10:47 pm
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50
What if you are certain that you can deduct the full amount of the DAF contribution this year, but realize that you might not be able to deduct the full amount (or any) in future years?
I think you've answered your own question. :D
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Using a donor-advised fund to minimize taxes

Post by scotthal »

willthrill81 wrote: Mon Nov 20, 2017 4:15 pm
scotthal wrote: Mon Nov 20, 2017 4:04 pm Oddly, the marginal tax rate (& thereby the DAF tax savings) tends to be higher for bogleheads in the 15% bracket than those in the 25% bracket.
How can a marginal tax rate be higher for those in the 15% bracket than those in the 25% bracket? :confused
If you're in the 15% bracket, the deduction reduces your ordinary income & can suck LT capital gains from 15% down to 0%. Yields a net 30% marginal tax rate. State income taxes complicate things - I live in Oregon, and figure my marginal federal+state tax rates to be 36/32/37% respectively for the 15/25/28% federal tax brackets.
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Re: Using a donor-advised fund to minimize taxes

Post by PhysicianOnFIRE »

scotthal wrote: Mon Nov 20, 2017 5:13 pm
willthrill81 wrote: Mon Nov 20, 2017 4:15 pm
scotthal wrote: Mon Nov 20, 2017 4:04 pm Oddly, the marginal tax rate (& thereby the DAF tax savings) tends to be higher for bogleheads in the 15% bracket than those in the 25% bracket.
How can a marginal tax rate be higher for those in the 15% bracket than those in the 25% bracket? :confused
If you're in the 15% bracket, the deduction reduces your ordinary income & can suck LT capital gains from 15% down to 0%. Yields a net 30% marginal tax rate. State income taxes complicate things - I live in Oregon, and figure my marginal federal+state tax rates to be 36/32/37% respectively for the 15/25/28% federal tax brackets.
Yes, that sneaky 30% bracket for those with capital gains in the 15% bracket. Explained in detail by "Big ERN" in this article at Early Retirement Now.

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Re: Using a donor-advised fund to minimize taxes

Post by grabiner »

scotthal wrote: Mon Nov 20, 2017 5:13 pm
willthrill81 wrote: Mon Nov 20, 2017 4:15 pm
scotthal wrote: Mon Nov 20, 2017 4:04 pm Oddly, the marginal tax rate (& thereby the DAF tax savings) tends to be higher for bogleheads in the 15% bracket than those in the 25% bracket.
How can a marginal tax rate be higher for those in the 15% bracket than those in the 25% bracket? :confused
If you're in the 15% bracket, the deduction reduces your ordinary income & can suck LT capital gains from 15% down to 0%. Yields a net 30% marginal tax rate. State income taxes complicate things - I live in Oregon, and figure my marginal federal+state tax rates to be 36/32/37% respectively for the 15/25/28% federal tax brackets.
Another common situation is retirees taking Social Security. If you are in the phase-in for SS taxation, each additional $1 of income makes 85 cents of SS taxable. This makes the marginal rate 27.75% in the 15% bracket, but most retirees in the 25% bracket are beyond the phase-in. (Those few who are in the phase-in have a marginal rate of 46.25%, which makes qualified charitable distributions particularly attractive.)
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Re: Using a donor-advised fund to minimize taxes

Post by FIREchief »

willthrill81 wrote: Mon Nov 20, 2017 5:07 pm
FIREchief wrote: Mon Nov 20, 2017 5:05 pm
willthrill81 wrote: Sun Nov 19, 2017 10:47 pm
Someone else I was talking with demonstrated to me that, apart from tax bracket changes, there is no difference in one's net worth whether one donates to a DAF now, gets the tax deduction, and invests that tax deduction or simply holds on to the after-tax funds in a taxable account and donates them later.

Instance #1
Invest $100 in a taxable account;
In ten years, the $100 is now worth $200;
$200 is donated to a DAF; and
In the 25% tax bracket, a $50 tax deduction is taken.

Instance #2
Donate $100 to a DAF while in the 25% tax bracket;
Receive a $25 tax deduction;
Invest that $25; and
In ten years, the $100 is now worth $200, and the $25 is now worth $50
What if you are certain that you can deduct the full amount of the DAF contribution this year, but realize that you might not be able to deduct the full amount (or any) in future years?
I think you've answered your own question. :D
Yes. It was a rhetorical question, intended to make a point. If I say anything else I might approach a boundary..... 8-)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.
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