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Last year, I set up a donor-advised fund through Schwab Charitable. I established this fund to streamline the process of donating to a charity using appreciated stock. After opening this account, I've discovered unanticipated benefits as well as a few drawbacks.
Here are some things to know about a donor-advised fund:
There are many ways to give; a donor-advised fund is one
I've given to charities by writing a check, charging a credit card, giving cash, donating needed supplies, donating items for resale, volunteering my time, and transferring appreciated stock. Generally, I'll get a tax receipt when I make a donation — either at the time of the gift or at the end of the year in a summary-of-giving statement.
I can include these donated amounts in my itemized deductions when I file my taxes. Note that I'd need to itemize my deductions (not claim the standard deduction) to snag the tax benefit of making charitable contributions.
Transferring appreciated stock to a charity is similar to using a donor-advised fund
Giving shares of appreciated stock that I've owned for more than a year and held in a taxable account is similar to transferring shares to a donor-advised fund. Both can be tax-efficient methods of giving.
When I make a donation of stock, generally I'll receive a tax receipt indicating the value of the shares when they're transferred.
If I simply sell the shares on the open market and donate the proceeds, I'd still get a tax receipt for the donation. But, I may owe taxes on the capital gain from the sale.
If my income is moderate and places me in the 10% or 15% tax bracket, my capital gains are taxed at 0%. In this scenario, selling shares doesn't trigger capital gains taxes.
However, if my taxable income places me in a higher tax bracket, I'll owe taxes on the capital gain. I'd be better off — in terms of taxation — making the transfer. Because I might not know my annual taxable income until I file taxes, it makes sense to initiate a transfer.
From what I can discern, transferring appreciated stock to an eligible charity is the same tax-wise as transferring shares to a donor-advised fund.
Giving through a donor-advised fund streamlines the process of donating appreciated stocks
The problems I've had with transferring shares to a charity have been a lack of follow-up and lack of proper documentation, even among organizations that claimed to welcome this type of giving.
For example, on two separate occasions, I've had to make follow-up phone calls to confirm that a charity received my donation. Another time, I was told that the organization could issue just a handwritten receipt, not a printed one, as the exact value of the donation was unclear. I'm not sure if my experiences are typical, but they prompted me to seek a better solution in regard to giving appreciated stock.
When I transferred stock to Schwab Charitable, I received a printed documentation of my gift and tax receipt within days.
Filling out the transfer forms took some effort. The stock I transferred was held with a different brokerage company so I had to make sure my original firm communicated with Schwab. For the first transfer, I asked Schwab to initiate the transfer; it was delayed when the firm couldn't recognize my account number on forms that were faxed and re-faxed (at the firm's suggestion). A phone call to my broker remedied the problem and completed the transfer.
For my second effort, I initiated the transfer with my brokerage firm. As the move was being made, I received a call from Schwab verifying the transfer. The transfers weren't seamless but were simpler than other methods.
Contributions to a donor-advised fund are irrevocable
The caller from Schwab wanted to make sure I understood one thing: this transfer of shares away from my brokerage account to the donor-advised fund was irrevocable. So, I couldn't change my mind. If I needed some extra cash in the future, I couldn't transfer shares back to my personal account and sell them to generate funds.
The shares I transferred were no longer mine. I could use this money for charitable purposes only.
Because my husband and I give regularly to our church, this irrevocable rule didn't bother me. However, the call reminded me that I need to be sure my savings and investments cover my expenses before I transfer too much of my wealth to a special fund for charitable giving only.
Several financial institutions offer donor-advised funds
Until recently, my knowledge about donor-advised funds and more complex methods of charitable giving was limited. I'd heard of starting a foundation and orchestrating gifts through the foundation. I thought that perhaps investing within a foundation or similar setup could eventually result in generating funds for charitable giving through investment earnings, not just same-year donations.
For example, the Morehead Scholar program (now Morehead-Cain at The University of North Carolina at Chapel Hill) was conceived using this approach. Locally, The Winston-Salem Foundation offers services that allow donors to establish their own foundation-like trusts, which I now realize are donor-advised funds.
While reading The Charles Schwab Guide to Finances After Fifty by Carrie Schwab-Pomerantz, I learned about Schwab's donor-advised fund. Soon afterward, a friend mentioned having this type of account. After conducting research, I discovered that several financial institutions offer some form of a donor-advised fund or charitable trust. Schwab, Fidelity Charitable, Bank of America, and Wells Fargo Private Bank are among those that provide these services to clients.
Minimums and fees for donor-advised funds vary
Schwab Charitable and Fidelity Charitable designed their accounts to make them accessible to the average person. The minimum to open an account is $5,000 and grants (donations) can be as little as $50.
Based on my research, I'd need $25,000 at Bank of America and $100,000 at Wells Fargo Private Bank to establish similar accounts.
There are restrictions on grant recommendations
The rules pertaining to grant recommendations are stricter than ordinary charitable giving. That's because I've already received a tax deduction for contributing to the donor-advised fund. So moving money from the fund to a designated charity (via a grant) must meet precise definitions for tax deductibility.
For example, I probably don't want to use this fund to purchase tickets to a charity event that includes dinner. This type of charitable “gift” combines making a donation with receiving a tangible benefit. Let's say event tickets are priced at $500 and the value of the meal is $100. Generally, the donation ($400) is deductible but the fair market value of the meal ($100) isn't. In fact, Schwab Charitable covers how to handle this type of situation in its guide to events and membership.
It's unlikely that I'll be attending a $500 charity gala. However, I may make a donation to sponsor myself in Bike MS, a two-day cycling event where I'd receive rest-stop support, meals, and snacks (presumably, a tangible benefit). So, if I decide to participate this year, I'll donate by charging any event-related fees on my credit card.
In addition, grant funds can't be applied to satisfying a legally-binding pledge or benefit a specific individual so certain types of giving may not be conducive to this method. For example, I couldn't give to a friend's GoFundMe.com account using the donor-advised fund.
I can invest the money inside of the donor-advised fund
Right now, I'm holding my money in a money market fund while I determine the best allocation for this new portfolio. I plan to contribute about one-third to one-half of the funds to my church this year, so my time horizon is relatively short for some of the money. I'd like to keep this money in a cash or similar type of allocation.
For the rest, though, I'd like to invest the money so that it can grow. Ideally, I'd like to be able to donate more than I actually gave in the first place. For core accounts with balances of $250,000 or less (like mine), I can build my own portfolio by choosing among a small selection of index and actively managed funds or selecting a fund with a preset asset allocation (similar to an target-date fund).
As far as I can tell, I can't set aside a certain dollar amount in cash or money market funds and invest the rest. The entire amount must be invested according to a specified asset allocation in terms of percentages. When I recommend a grant, I'm not sure how funds will be generated. In the coming months, I'll see how my portfolio is tapped and reallocated when cash is needed.
What I don't and do like about a donor-advised fund:
Now that I've funded the account, I realize that simply transferring shares of appreciated stock when I'm ready to give could be a simpler and more flexible way to make charitable donations.
Still, I'm glad to have opened the donor-advised fund. I like being able to separate my contributions for tax purposes from my actual contributions. With this feature, I can increase charitable contributions to boost itemized deductions in one year and claim the standard deduction in other years.
In addition, I like being able to make smaller donations using this account. I couldn't transfer a few shares to a charity but I can transfer a bunch to the donor-advised fund and then make gifts of $50 or $100 for special causes from the fund.
Just as significantly, I've begun to like the idea of designating certain accounts for certain purposes, such as this fund for charity. That makes the process almost effortless to me.