When you decide that it is time to help your favorite charity, you may instinctively reach for your checkbook. But here may be a better way to support your favorite causes while enjoying even more personal benefit.
In my book, “Don’t Run Out of Money in Retirement: How to Increase Income, Avoid Taxes, and Keep More of What is Yours,” I discuss how, every year, millions of Americans donate to charity. It is a nice thing to do and one of the more common ways of reducing taxes. A few options are listed in the book, but, today, I want to talk about donor-advised funds. A donor-advised fund (DAF) can help charitably inclined investors get more mileage out of their donated dollars and also help them walk away with an immediate tax deduction.
Donor-advised funds are broadly used. According to the National Philanthropic Trust, more than 1.2 million DAFs totaled $234 billion of charitable assets in 2021. The allure of a DAF is that, when you contribute to the fund, you may be eligible to claim an itemized tax deduction for federal and/or state tax purposes in the year of the contribution. This benefit is available to donors even if no assets were distributed to a charity that year. Plus, donors will not be taxed on any growth of assets in the fund. This tax-free growth allows for even more support for your charities of choice.
Deductions for DAF contributions are generally limited to 50 percent of adjusted gross income (AGI). The limit increases to 60 percent of AGI for cash gifts. The limit for donating appreciated non-cash assets held for more than one year is 30 percent of AGI. Contributions in excess of those limits can be carried over for up to five subsequent years.
One tax-avoidance tactic is to donate an asset with unrealized capital gains directly into the DAF. This donation could be a liquid investment, like a company stock. Or it could be an illiquid asset, like inherited ownership of a parent’s company or art. If the donor were to have sold the asset and given the proceeds to a charity, the donor would have had to pay taxes on the gains, reducing the amount available for philanthropy. However, donors of appreciated assets not only elude the capital gains tax but also receive a tax deduction of up to 30 percent of their AGI. An even more sophisticated technique would be to sell available share lots that have not appreciated, allowing that portion of the proceeds to benefit from a 60 percent tax deduction.
If you want to go deeper, consider the cascading benefits. (But let’s not go too deep because it gets wonky). If you file for Medicare, a DAF contribution could help you avoid a special monthly surcharge on premiums for Medicare Part B (which covers some doctor’s bills, medical equipment, and home health care). Medicare Part B will cost most people about $1,979 per year. However, according to Fortune Well, about seven percent of people get hit with that surcharge, known as an Income-Related Monthly Adjustment Amount (IRMAA).
In 2023, the IRMAA surcharge could increase the annual cost to $6,732 for Medicare Part B. An IRMAA surcharge for Medicare Part D plans (prescription drug coverage) could cost you another $912 annually.
The bottom line regarding DAFs and Medicare is that if your modified adjusted gross income (MAGI) exceeds a certain amount, you might get stuck paying almost $8,000 more yearly. A tactically made DAF donation could reduce your income enough to avoid getting stuck with that increased cost. (Keep in mind, a DAF isn’t the only trick available to avoid that surcharge.)
The downside to DAFs is that they are irrevocable, so you must be sure you really want that tax-free growth to benefit your charities and the immediate tax deduction to benefit you. Grants must go to a public 501(c)(3) nonprofit organization; you can’t give those donations to your kids to buy a house or pay for a wedding. However, grants can fund scholarship opportunities if student criteria are met.
Knowing the facts is one thing. Hearing the stories is another. You can click here to watch four short videos of charitable investors. I invite you to listen to see if their stories resonate with your intentions.
A recession is looming
As an investor, my biggest challenge for the next couple of years might be determining when to shift from investing for the long term to protecting for the short term. A U.S. recession is looming, and that type of economic challenge punishes investment portfolios.
The Leading Economic Index is a tried-and-true recession indicator. It fell in August, its 17th month in a row of contraction.
The LEI has never declined for this long and by this much without a recession occurring shortly thereafter. I am growing less hopeful that an NBER-defined recession can be staved off until 2025.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
