DAF to the max: Potential Tax Arbitrage Strategy

[Toddtheformeraccountant]

So my situation is that I'm retiring next year, and this is the last year that I will be in the maximum federal and state tax brackets (ugh...13.3% state, 37% federal, so more than half goes to tax man...part of the reason I'm retirement lol). Last few years I've been using a donor advised fund (DAF) to fund all my charitable contributions to my church and elsewhere...using appreciated VOO stock...I give 10% of my earnings to charity ("tithing" concept as a christian, for clarity).

So I got to thinking, given that I will continue to give 10% of my income (including recognized capital gains, interest, dividends) to charity, after I retire that will be much lower. So seems like a no-brainer to calculate the present value of all my future charitable contributions..based upon where retirement funds will be, taxable funds will be, dividends, capital gains, etc. (and tax thereon)...and fund that amount today in the DAF with appreciated stock, getting a deduction this year which has a 50.3% value in tax savings. So I won't get deductions in the future for my 10% disbursed to charities from my DAF....but my tax rate will be much lower. And the "earnings" on the DAF will not be taxable either. So I'm ahead of the game.

Also, asset allocation in the DAF will mirror my other funds...so that the parallel charitable contribution fund will grow (or not) same as the other funds. If the market crashes, then the DAF crashes, if market booms, DAF booms, and I (theoretically) keep the "right" amount on hand at all times to satisfy my theoretical charitable contribution "liability."

Very simple, somewhat analogous tax arbitrage to the ROTH conversion scheme (which I will do as well).

Can anybody poke holes in this strategy?

[audreyh1]

Yes, fund it years ahead so you can be well above the standard deduction for once and not worry about getting high enough above the standard deduction to be worth it in future years. You get a better tax benefit by donating in a large lump.

We did that over a couple of years with highly appreciated stock just before the tax laws changed raising the standard deduction and limiting deductions for state/sales and property taxes. Now the DAF is funded for at least 10 years, and after that we’ll switch to QCDs directly from IRAs.

[OldShooter]

What happens to the DAF when you die? Maybe next year or in five years? Is that OK?

[Toddtheformeraccountant]

Quote:

Originally Posted by OldShooter What happens to the DAF when you die? Maybe next year or in five years? Is that OK?

I will put in our will (and instruct the kids) that the DAF needs to be distributed when we die to cover the accumulated capital gain, that the kids can then decide where the rest goes...they inherit the "funds" equally. Can use them to fund their charitable contributions, or distribute it all out day 1, up to them.

[Toddtheformeraccountant]

Quote:

Originally Posted by audreyh1 Yes, fund it years ahead so you can be well above the standard deduction for once and not worry about getting high enough above the standard deduction to be worth it in future years We did that over a couple of years with highly appreciated stock just before the tax laws changed raising the standard deduction and limiting deductions for state/sales and property taxes. Now the DAF is funded for at least 10 years, and after that we’ll switch to QCDs directly from IRAs.

Thank you Audreyh...nothing like hearing someone else did it to make me not feel like I'm doing something risky or silly or missing something obvious!

[RunningBum]

I set up and funded a DAF the last year I itemized, and had more income to make the charity deduction more worthwhile. I wasn't near your tax bracket, so you are getting even more benefit from this.

Quote:

Originally Posted by Toddtheformeraccountant I will put in our will (and instruct the kids) that the DAF needs to be distributed when we die to cover the accumulated capital gain, that the kids can then decide where the rest goes...they inherit the "funds" equally. Can use them to fund their charitable contributions, or distribute it all out day 1, up to them.

I don't follow what you are saying here. Once you fund the DAF, there is no accumulated capital gain. There is no tax consequence of growth or loss in a DAF, and no tax consequence of distributions since you've already taken the tax deduction when you funded the DAT.

Also, the DAF is no longer an asset of yours, so it's not something you can control with a will, as far as I know.

The options, I believe, are to designate a final distribution of funds to the charity or charities of choice, or designate a successor to administer the DAF. Failure to do either rolls it into the institutions endowment funds--it still goes to some charity, but not of your picking. So you can name a child as successor and ask them to continue with the endowment strategy you had, or leave other instructions for them (outside of a will or the DAF) but it's not enforceable. Different institutions may have different rules but I think the above is common.

I just named my son as successor of mine, and leave it to him to choose his charities of choice. I'm not going to try to control this from the grave.

[RunningBum]

One more rule to consider, I believe the institution has to distribute 5% of it's holdings to charities. Individual accounts do not have to meet this, but the institution can require you to do so if they are not going to meet the requirement. I'm citing this from memory and it may not be exactly right, but I try to distribute at least 5% per year anyway.

[RunningBum]

The risk in all of this is that you've committed the money. If you have some major family issue where you unexpectedly need money, you can't retract the funding you made to the DAF. It's gone.

[audreyh1]

Quote:

Originally Posted by OldShooter What happens to the DAF when you die? Maybe next year or in five years? Is that OK?

You can assign someone to continue gifting from it, or you can specify which charities it goes to on your death. The default is it goes to some charities predetermined by the administrators.

Once donated it’s donated and no longer your money. You may control it, but it’s already committed to charities. It’s subject to the rules of the institution administering the DAF. You can’t control it from a will.

[audreyh1]

Quote:

Originally Posted by RunningBum One more rule to consider, I believe the institution has to distribute 5% of it's holdings to charities. Individual accounts do not have to meet this, but the institution can require you to do so if they are not going to meet the requirement. I'm citing this from memory and it may not be exactly right, but I try to distribute at least 5% per year anyway.

This very much depends.

[audreyh1]

Our asset allocation in the DAF reflects the number of years we expect to use it. Some funds each year. So it’s more conservatively invested than our retirement funds.

[RunningBum]

Quote:

Originally Posted by audreyh1 This very much depends.

This is what Fidelity says. It's not clear to me to me if this is a federal requirement or just their policy, so it may be different at other account holders.

Quote:

Minimum Fidelity Charitable grant activity Historically, Fidelity Charitable has made grants of about 20% of average net total assets to charities each year. The formal grantmaking policy requires that minimum annual grants, on an overall basis, be greater than 5% of average net assets on a fiscal five-year rolling basis. If this requirement is not met in a fiscal year, Fidelity Charitable will ask for grant recommendations from Giving Accounts that have not had grant activity of at least 5% of the Giving Account’s average net assets over the same five-year period. If Account Holders on these Giving Accounts do not make grant recommendations within 60 days, Fidelity Charitable will grant the required amounts out in accordance with the Fidelity Charitable Trustees’ Initiative (described on page 27), in its sole discretion.

I couldn't easily post the link to the pdf this is from. I found it by googling "Fidelity DAF Rules 5%"

[OldShooter]

Quote:

Originally Posted by RunningBum This is what Fidelity says. It's not clear to me to me if this is a federal requirement or just their policy ...

DW is on grants committees for a couple of large (8 digit) charitable trusts and for them the 5% is an IRS requirement. So probably it is at Fido too as it sounds like the DAFs there look to the IRS like one big charitable trust.

[audreyh1]

Quote:

Originally Posted by RunningBum This is what Fidelity says. It's not clear to me to me if this is a federal requirement or just their policy, so it may be different at other account holders. I couldn't easily post the link to the pdf this is from. I found it by googling "Fidelity DAF Rules 5%"

Some levels of it is driven by federal regulations, but if others in the pool are gifting generously, with some administrators you may be let off the hook for a while. The rules apply to the pool as a whole, not individual funds.

[Toddtheformeraccountant]

Quote:

Originally Posted by RunningBum I set up and funded a DAF the last year I itemized, and had more income to make the charity deduction more worthwhile. I wasn't near your tax bracket, so you are getting even more benefit from this. I don't follow what you are saying here. Once you fund the DAF, there is no accumulated capital gain. There is no tax consequence of growth or loss in a DAF, and no tax consequence of distributions since you've already taken the tax deduction when you funded the DAT. Also, the DAF is no longer an asset of yours, so it's not something you can control with a will, as far as I know. The options, I believe, are to designate a final distribution of funds to the charity or charities of choice, or designate a successor to administer the DAF. Failure to do either rolls it into the institutions endowment funds--it still goes to some charity, but not of your picking. So you can name a child as successor and ask them to continue with the endowment strategy you had, or leave other instructions for them (outside of a will or the DAF) but it's not enforceable. Different institutions may have different rules but I think the above is common. I just named my son as successor of mine, and leave it to him to choose his charities of choice. I'm not going to try to control this from the grave.

Thanks Runningbum..very helpful comments. Yeah, I will name the wife then the kids as successors, not really worried about controlling after I die, as you suggest. I'm saying accumulated capital gain from a "tithing" (giving a percentage of "income") perspective...interest, dividends, work income, and capital gain are all "income."

[Toddtheformeraccountant]

Quote:

Originally Posted by RunningBum This is what Fidelity says. It's not clear to me to me if this is a federal requirement or just their policy, so it may be different at other account holders. I couldn't easily post the link to the pdf this is from. I found it by googling "Fidelity DAF Rules 5%"

Hmm..thank you...that's something I hadn't contemplated. I think that my contributions would be at least 5% each year over a 5-year period...but I'll have to gauge that to make sure I'm don't get stuck in that trap.

[RunningBum]

Quote:

Originally Posted by audreyh1 Some levels of it is driven by federal regulations, but if others in the pool are gifting generously, with some administrators you may be let off the hook for a while. The rules apply to the pool as a whole, not individual funds.

That's exactly what I said.

Individual accounts do not have to meet this, but the institution can require you to do so if they are not going to meet the requirement.

[Clone]

I am also considering a DAF to allow me to bunch up the contributions into a year when we will itemize deductions, and then disperse them over several years when we will take the standard deduction. We are nowhere close to the same type of tax bracket, but the concept is the same. Make a big contribution to the DAF, increase the amount of Roth conversions, and it washes out in the tax game. (Given the assumption that you are going to donate that amount of money at some point in time anyway.)

[audreyh1]

I think that is the major benefit of a DAF - allowing one to bunch up donations in a big way but still being able to disperse them evenly over many years.

We used to be able to bunch up deductions such that we would benefit from itemizing every other year and those were good years to contribute to our DAF. Then the tax laws changed, significantly raising the standard deduction and putting limits on state/sales and property tax deductions. For us now it would take several years of charitable deductions to be worth itemizing. I’m glad we aggressively preloaded our DAF before the changes.

[BeachOrCity]

Definitely fund the DAF this year.

As for how much. I would think about the total amount you think you will give between retirement and RMD year 1 around 70+ years old and maybe fund 1/2 to 3/4 of that to allow for appreciation and flexibility. If 2020 income will be equally high consider splitting to get that max tax bracket advantage.

Post rmd the DAF doesn’t give a real advantage.

Also make sure you pick the “right” DAF or split it up. Vanguard has 500 minimum. Sometimes you want to give 50 bucks to a charity. Some cost more than others fees wise.

Glad to hear you are making the leap.