$125K Tax Savings: Donor-Advised Fund Strategy

$125K Tax Savings: Donor-Advised Fund Strategy

Executive Summary

High-net-worth individuals often seek efficient strategies for charitable giving that also minimize their tax burden. A client, facing substantial capital gains taxes from highly appreciated stock, needed a solution that allowed for ongoing charitable donations while providing immediate tax relief. Golden Door Asset implemented a donor-advised fund (DAF) strategy, enabling the client to donate appreciated assets, claim a significant tax deduction, and maintain control over the disbursement of funds to various charities. This strategy resulted in $125,000 in tax savings over five years and streamlined the client's charitable giving process.

The Challenge

Mr. and Mrs. Thompson, a couple approaching retirement with a net worth exceeding $5 million, were actively involved in several charitable organizations. They had historically made annual cash donations, but their taxable income was consistently high, resulting in a significant tax liability each year. They held approximately $750,000 worth of stock in a publicly traded technology company, acquired several years ago at an average cost basis of $50,000. Selling this stock would trigger substantial capital gains taxes, estimated at 20% federal plus applicable state taxes, potentially eroding their charitable giving capacity and overall financial security.

Moreover, the Thompsons desired flexibility in their charitable giving. They supported numerous causes and wanted the ability to recommend grants to different organizations at varying times throughout the year, without the administrative burden of managing multiple individual donations. Their existing approach lacked a centralized system for tracking donations and maximizing tax benefits, ultimately limiting their charitable impact and increasing their tax burden. They had budgeted $25,000 per year for charitable contributions, but felt this amount could be optimized through a more tax-efficient strategy.

Their prior strategy involved simply writing checks to charities. While well-intentioned, this approach lacked the sophistication required to maximize tax benefits and lacked any strategic planning for long-term charitable goals. They sought a solution that would not only reduce their tax liability but also provide a more structured and flexible framework for their philanthropic endeavors. They wanted a system that was easy to manage and aligned with their long-term financial objectives.

The Approach

Golden Door Asset's approach centered around establishing a donor-advised fund (DAF) as the cornerstone of the Thompsons' charitable giving strategy. We meticulously evaluated their financial situation, including their income, assets, tax bracket, and charitable goals, to determine the optimal level of contribution to the DAF.

Our analysis revealed that donating the appreciated stock to the DAF, rather than selling it and then donating the proceeds, would provide significant tax advantages. The Thompsons could deduct the fair market value of the donated stock (up to 30% of their adjusted gross income) and avoid paying capital gains taxes on the appreciation. This approach immediately addressed their capital gains tax concerns and allowed them to donate a larger amount to charity than if they had sold the stock and paid taxes first.

We then guided the Thompsons in selecting a DAF provider that aligned with their specific needs and preferences. Factors considered included the provider's investment options, administrative fees, grant-making policies, and overall reputation. We presented them with options from Fidelity Charitable, Schwab Charitable, and Vanguard Charitable, highlighting the strengths and weaknesses of each. Ultimately, they chose Fidelity Charitable due to its robust investment platform and flexible grant-making policies.

We also developed a grant distribution strategy, working with the Thompsons to identify their core charitable interests and create a plan for allocating funds to various organizations over time. This strategy ensured that their charitable giving aligned with their values and had a meaningful impact on the causes they supported. We projected the tax benefits of this strategy over a five-year period, demonstrating the potential for significant savings.

Our strategic thinking emphasized long-term financial planning. By integrating the DAF strategy into the Thompsons' overall financial plan, we ensured that their charitable giving was aligned with their retirement goals and other financial objectives. This holistic approach provided them with peace of mind and maximized the overall value of their financial plan.

Technical Implementation

The technical implementation involved several key steps:

1. Asset Valuation: We obtained an accurate valuation of the appreciated stock to determine the fair market value for tax deduction purposes. This involved consulting with a qualified appraiser and utilizing reputable financial data sources.

2. DAF Establishment: We assisted the Thompsons in completing the necessary paperwork to establish the DAF with Fidelity Charitable. This included providing documentation of their income, assets, and charitable intent.

3. Stock Transfer: We facilitated the transfer of the appreciated stock to the DAF. This involved working with their brokerage account and Fidelity Charitable to ensure a seamless and tax-efficient transfer. The transfer was structured to avoid triggering any taxable events.

4. Tax Deduction Calculation: We calculated the amount of the charitable deduction that the Thompsons could claim on their tax return. This calculation took into account the fair market value of the donated stock, the applicable AGI limitations, and any other relevant tax rules. We used tax planning software to model the impact of the deduction on their overall tax liability. The deduction was capped at 30% of their adjusted gross income (AGI).

5. Grant Recommendation: We guided the Thompsons in making grant recommendations from the DAF to various charities. This involved researching and vetting potential recipient organizations and ensuring that they met the requirements for tax-exempt status.

6. Performance Monitoring: We continuously monitored the performance of the DAF investments and provided regular reports to the Thompsons. This ensured that the DAF was growing in value and generating sufficient funds to support their charitable giving goals.

7. Tax Optimization: We continuously monitored changes in tax laws and regulations to identify opportunities to further optimize the Thompsons' charitable giving strategy. This included exploring the use of other charitable giving vehicles, such as charitable remainder trusts. We also analyzed their tax situation each year to ensure that they were maximizing their tax benefits.

The calculations involved utilizing IRS guidelines for charitable contributions of appreciated property, specifically understanding the limitations on deductions based on AGI and the character of the asset. We used Monte Carlo simulations within the Golden Door Asset platform to project potential DAF growth scenarios and their impact on future grant-making capacity.

Results & ROI

The implementation of the donor-advised fund strategy yielded significant results for the Thompsons:

• Tax Savings: Over the five-year period, the Thompsons realized a total of $125,000 in tax savings. This included avoiding capital gains taxes on the appreciated stock and claiming charitable deductions each year. This amounts to an average of $25,000 per year in tax savings.

• Increased Charitable Giving: By donating the appreciated stock directly to the DAF, the Thompsons were able to donate a larger amount to charity than if they had sold the stock and paid taxes first. This allowed them to increase their annual charitable giving by approximately 15%.

• Streamlined Administration: The DAF provided a centralized system for managing their charitable contributions, simplifying the administrative burden and allowing them to focus on their philanthropic goals.

• Investment Growth: The DAF investments grew in value over time, increasing the funds available for charitable giving. The average annual return on their DAF investments was 7%, further enhancing their charitable capacity.

• Financial Clarity: The strategy provided the Thompsons with greater clarity and control over their charitable giving, allowing them to align their philanthropy with their long-term financial objectives. They were able to track their donations and monitor the impact of their giving.

Before the DAF, their effective tax rate was around 30%. Post-DAF implementation and strategic contribution, their effective tax rate dropped to 25%, a tangible demonstration of the tax efficiency gained. They were also able to donate approximately $30,000 in assets annually instead of their previous $25,000 annual cash donations, allowing them to increase their charitable impact by 20%.

Key Takeaways

1. Appreciated Assets Are Powerful Giving Tools: Donating appreciated assets, such as stocks or real estate, to a DAF can provide significant tax advantages, allowing clients to avoid capital gains taxes and claim a charitable deduction.

2. Donor-Advised Funds Offer Flexibility and Control: DAFs provide clients with flexibility in their charitable giving, allowing them to recommend grants to different organizations at varying times throughout the year.

3. Strategic Planning is Essential: Integrating charitable giving into a client's overall financial plan is crucial for maximizing tax benefits and ensuring that their philanthropy aligns with their long-term financial objectives.

4. Consider the AGI Limitation: Be mindful of the adjusted gross income (AGI) limitations on charitable deductions and structure contributions accordingly to maximize tax benefits. Donations of property are limited to 30% of AGI.

5. Diversify Investment Options within the DAF: The DAF is more than just a tool to distribute funds, it's also an investment account. Be sure to diversify investment options based on the individual's risk tolerance and charitable goals.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors proactively identify tax-saving opportunities for clients, like the DAF strategy outlined above, and optimize financial plans with data-driven insights. Visit our tools to see how we can help your practice.