For individuals who are currently charitably inclined or who aspire to be at some point, a Donor Advised Fund (DAF) can be a great tool to unlock several potential retirement and tax planning strategies.
What is a Donor Advised Fund (DAF)
A DAF is nothing more than a charitable investment account that you set up to provide simple, flexible, and efficient ways to manage charitable giving. A DAF account is set up through a non-profit sponsoring organization known as a DAF host. DAF hosts are qualified public charities that serve as the administrator of the DAF and help you direct grants to qualified charities and non-profit organizations on your timetable. The DAF host handles the accounting and reporting and assures compliance with IRS rules. A good DAF host will also help you develop and achieve your charitable goals by providing educational resources and research tools.
At Thrive Retirement Specialists, we often refer our clients seeking a DAF host to the American Endowment Foundation due to their combination of reputation, cost, ease of use, and relationship with TD Ameritrade (which allows us to manage the DAF investment account on our clients’ behalf – for no additional charge because of our flat fee!!). See our Insight entitled, "Why a Flat Fee Advisor is Best for Retirees" for more.
Because the DAF host is a qualified charitable organization, the money or assets donated into a DAF becomes an irrevocable transfer to a public charity, and you immediately realize the tax benefits of the donation. The donor immediately receives the following three tax benefits at the time of donation (they also retain the right to direct, or grant, the donations made to charities of their choice at a later date):
- An immediate tax deduction on adjusted gross income (assuming itemized deductions exceed the standard deduction)
- The avoidance of capital gains on assets donated to the DAF
- A reduction of the gross estate by the amount of the excluded asset
DAF as a Retirement and Tax Planning Tool
The tax benefits and giving flexibility of a DAF make it a great tool for retirement and tax planning. Following are four core strategies often used:
Some individuals support specific charities or non-profit organizations with regular monthly, quarterly, or annual donations. A strategy known as charitable bunching through a DAF could yield significant tax savings for these individuals. Charitable deductions are only beneficial if, together with other itemized deductions, the amount exceeds the current standard deduction of $25,900. So donating multiple years of giving at once to a DAF to exceed the standard deduction can yield additional tax savings while allowing the individual to maintain the intended rate of donations and possibly even increase the size of their charitable giving through investment account growth.
For example, say a couple has an AGI of $300,000 (placing them at a 24% marginal tax rate) and gives $15,000 annually to their church. When added to the $15,000 donation, this couple's total itemized deductions come up just shy of the standard deduction of $25,900 each year. As can be seen in the example below, a bunching strategy could save this couple ~$14,400 in taxes in just five years:
Maximize Charitable Deduction Value in High Marginal Tax Rate Years
Many pre-retirees are at peak earnings in the years leading up to retirement. An individual with charitable intentions may choose to fund a DAF with the amounts they plan to give over their life during these peak earnings years to maximize the value of the charitable deductions given their high marginal income tax rates. The individual can then direct (or grant) the DAF funds to charities and non-profit organizations of their choice on their timetable later when they are under lower marginal tax rates in retirement. This strategy can be especially beneficial if an individual is still paying a mortgage and is near being able to itemize.
Lower Taxable Income in High Marginal Tax Rate Years
Roth IRA conversions tend to be less economically beneficial during peak earnings years requiring many pre-retirees to wait until retiring to begin executing on beneficial Roth IRA conversion strategies. While many factors drive value in a Roth IRA conversion strategy, two of the most important are time and marginal tax rate differential (See our Insight entitled "What Drives Value in a Roth IRA Conversion Strategy" for more). The greater the amount of time assets have in the Roth IRA to compound and forever remain tax-free, the better. Additionally, we are under a relatively favorable marginal tax rate environment under the Tax Cut and Jobs Act rates set to expire at the end of 2025. Marginal tax rates and income brackets are set to revert to the prior unfavorable marginal tax rate environment for 2026. Funding a DAF may help lower taxable income to a marginal tax rate level that favors starting a Roth IRA conversion strategy earlier.
Tax-Efficient Disposal of Low-Cost-Basis Assets You No Longer Wish to Hold
As one nears retirement, a prudent step to manage risk is to start transitioning one’s investment portfolio to a maximally diversified portfolio of low-cost index funds. There is less time to recover from mistakes now, so concentrated risk bets (i.e., individual stocks) should be avoided. See our Insight entitled "Building an Investment Portfolio for Retirement" for more. The problem may be that you have some really low-cost-basis assets in your account that you’ve held for years, and you do not want to sell and realize the capital gains. This is another problem the DAF is great at solving.
Donating a low-cost basis asset to a DAF yields a double-tax benefit. First, you get an income tax deduction equal to the asset's market value at the time of donation. Second, you get to remove the asset from your balance sheet without ever having to pay capital gains on the asset's appreciation. This could represent significant tax savings, as can be seen in the example below:
Extract Value from All Four Strategies
These four core strategies were isolated for the sake of explanation. In practice, many individuals tend to extract value from elements of all four of these strategies at once. An overarching strategy should be developed that is coordinated with your overall retirement plan and that takes into consideration IRS limits to charitable deductions. While nothing in retirement and tax planning is easy, it is easy for those with charitable intent to see why DAFs are such a popular retirement and tax planning tool.
If you would like help establishing a donor advised fund as part of a retirement and tax plan, we stand by ready to help. To learn more, you can schedule a friendly, informal call for a date and time that is convenient for you here at this link: https://calendly.com/thriveretire/thriveretire-call or contact us here at any time.
ABOUT THRIVE RETIREMENT SPECIALISTS
Thrive Retirement Specialists is a retirement planning specialist dedicated to delivering a more thoughtful and strategic approach to retirement planning for those nearing or in retirement. We are a fee-only Registered Investment Advisor (RIA) offering a single, flat-fee service entitled ThriveRetire™ that goes far beyond what has traditionally been known as retirement planning. ThriveRetire™ is an engaging ongoing 8-step retirement planning process and investment management service that seeks to identify all risks, assets, tools, and tactics to develop an optimal retirement plan designed to support your ideal retirement lifestyle and goals to the fullest extent possible. With every interaction, we seek to inform and serve, so our clients can safely trust their ThriveRetire™ plan and process, leaving each client with the confidence and peace of mind to live a vibrant and full life through retirement.
ABOUT ANTHONY WATSON, CFA, CFP®, RICP®
Prior to founding Thrive Retirement Specialists, Tony spent eight years serving as the Chief Investment Officer of a firm where he provided advice and investment management services to over 600 individuals representing at the time over $1.5 billion of investments. Before this, Tony served as Vice President at J.P. Morgan Private Bank, where he advised high- and ultra-high net worth individuals on all matters of wealth, including investments, portfolio construction, portfolio management, and retirement planning.
Tony lives in Dearborn, Michigan, with his wife Dawn and daughters Emma and Anna.
- BBA in Finance, Walsh College
- MBA, University of Michigan, Ross School of Business
- Chartered Financial Analyst (CFA)
- Certified Financial Planner (CFP®)
- Retirement Income Certified Professional (RICP®)