When Should Retirees Consider a Donor-Advised Fund?

An older woman looks off to the side, thinking, while sitting at her kitchen table.

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published 3 October 2024

Too often, we think about charitable giving in the context of the rich and powerful, where, it seems, the rich keep getting richer via some complex charitable strategy. While there are significant tax benefits to properly structured charitable giving, the reality is much less exciting. You will save some percentage of your gift, if you do it properly, but you’ll always end up with less money than you started with. That’s the point: You’re giving away money.

When it comes to charitable planning, charitable intent must be the first box you check. Once you have decided you can afford to give and that you want to give, you have to decide how you’ll give. A donor-advised fund (DAF) may be that “how.” Put simply, a DAF is a financial account that allows you to make tax-deductible contributions of cash or assets, invest the money in the account tax-free and then recommend grants out of the account to your favorite charities over time. The tax deduction is recognized at the time you put the money into the DAF, regardless of when the money makes it to your charity of choice.

Below are four triggers that you can use as a hand-raising exercise. If you are charitably inclined and raised your hand to one or more of these triggers, you should evaluate a DAF. I have also used this strategy for many clients who are not in these situations, so this is by no means a comprehensive list.

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1. You just retired from a company or sold your business.

The typical tax trend for those who retire is down, then up. Once wages go away, but before you claim Social Security and take distributions from retirement accounts, your effective tax rate should be lower. Charitable contributions will be less impactful, as they offset a lower obligation. On the flip side, your last year working is often the one with the highest income and, therefore, the highest tax rate. If you are a business owner who has just sold a business, this is compounded.

A DAF will allow you to make large charitable contributions in that final year of work and take that deduction against a larger amount of gross income, without having to decide who you are giving to. You can make that decision in subsequent years when grants are made from the fund to the charities of your choice.

2. You sold your 'forever home.'

We are in the DC Metro area. It seems like in the past five years, every home purchased by a Boomer in the ’80s or ’90s is now worth over $1 million. This is an uptown problem as the owner, but it likely makes a portion of the gain taxable from the IRS perspective. Depending on the size of the gain and where you live, that can be substantial. A $500,000 gain in Maryland is likely to cost you $150,000 in federal and state taxes.

Like your last year of work, charitable giving has a bigger impact in years where your tax rates are especially high. Because this is a one-time hit, your rates will drop again next year. We often advise clients to make several years of charitable gifts in the year of sale and distribute those funds in future years as you would have under normal circumstances.

3. You want to diversify your investments out of a concentrated investment.

My sister works for Amazon. Like many tech companies, Amazon offers equity compensation to help attract top talent. While this is one of the best ways for my sister to build wealth over time, it creates risk in retirement. A concentrated position is typically considered to be one stock that represents more than 10% of your overall portfolio. For example, let’s say my sister retired with a portfolio worth $3 million and her Amazon stock represented $500,000. That would be a concentrated position.

A DAF would allow her to put shares, $200,000 in this case, of that stock into the fund. That would serve two purposes: It would give her a Schedule A deduction of $200,000 as well as allow her to avoid the capital gains tax she would have owed if she had sold the stock.

4. You no longer itemize.

In 2018, the Tax Cuts and Jobs Act (TCJA) significantly changed the tax code. The Tax Foundation estimates that only a third of taxpayers who itemized pre-TCJA itemize post-TCJA. In plain English, a very small percentage of taxpayers will actually be able to take a charitable deduction for their giving because they do not give more than the standard deduction.

This reality introduced a strategy called “charitable stacking,” where instead of giving every year, you give many years all at once. For example, instead of giving $10,000 per year over five years, you give $50,000 in one year and then don’t give for the subsequent four years. This allows you to get above the standard deduction in year one and receive a tax benefit for your giving.

The handy part of the DAF in this scenario is that this doesn’t have to disrupt the beneficiaries of your giving. You can make the donation into the DAF in year one and then make grants from that fund in future years, just as you would have if the funds were coming from your bank account.

Key questions before giving

When considering charitable giving, ask yourself these three questions in this order:

Is charitable giving the primary intent?
Can I afford to give?
How should I give?

This article is all about the last question.

Your financial plan should tell you whether you can afford to give. If you want to try a free version of the financial planning software we use, you can access it here.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.