Tools & Techniques 101: The Tandem Donor Advised Fund
Those who follow this blog know that I am a huge fan of the donor advised fund (DAF). It is an extremely helpful tool for donors at practically any income level to assist with both the timing of donations and the management of charitable funds. I don’t normally make blanket recommendations, but I think that anyone who invests in a taxable brokerage account and plans to donate more than a nominal amount to charity now or in the future should consider establishing and maintaining a DAF. It is as basic a tool to the investor/donor as a hammer is to a carpenter. Here’s why…
First off, the charitable contribution of appreciated long term securities yields an income tax deduction equal to the fair market value of the securities on the date of donation. The problem is, donating securities directly to charitable organizations, particularly smaller ones like churches and synagogues, is often cumbersome and puts an added burden on to the charity to dispose of the security once received. A better bet would be to establish a DAF in tandem with your taxable brokerage account and time your contributions to the DAF to maximize your tax advantages. Commercial vendors such as Schwab and Fidelity make this process very easy – a couple of clicks at the keyboard and your appreciated security is automatically transferred from your taxable brokerage account to your DAF. The contribution to the DAF qualifies as a charitable gift, and the ultimate distribution to your charity or charities of choice can be made at your leisure.
Think about the advantages – in February, a run-up in the market prompts you or your advisor to contemplate a rebalance of your portfolio. You normally make your charitable contributions in December. Why not kill two birds with one stone? You can accomplish some or all of the rebalancing in February by moving a portion of the long-term appreciated securities to your DAF (as opposed to selling them and incurring tax on the gain) and then in December, fund your gifts to your favorite charities using the DAF. You might argue that this strategy rebalances your account by diminishing it, but you can always replenish the brokerage account with fresh cash – cash that might ultimately have been used to fund your annual charitable contributions.
So here’s the takeaway:
- Consider establishing a DAF in tandem with your taxable brokerage account (IRA’s and other qualified plans don’t work for this strategy). Think of it as a permanent charitable/tax planning tool at your disposal at any time.
- When rebalancing your brokerage account, shift some of the appreciated securities to the DAF. Doing so provides you with a “1-2 punch” – a current year charitable contribution at fair market value and avoidance of capital gains tax and the new Federal tax on net investment income. Consider adding new cash to the brokerage account to replace the FMV shifted to the DAF.
- Do NOT fund the DAF with short term appreciated securities because the contribution will be limited to basis and certainly don’t use depreciated securities! If it fits with your investment plans, it is better to sell the depreciated securities, realize the loss to reduce your taxable income, and then use the resulting cash proceeds to fund your contribution.