In our Q&A last month, we discussed bunching charitable contributions as a potential strategic option to lower your tax bill. Bunching contributions involves making multiple years’ worth of charitable contributions in a single year. This enables you to itemize deductions for that year while taking advantage of the standard deduction in subsequent years. This month, we’re taking the question a step further to address the benefits of donor-advised funds when bunching contributions.
What is a donor-advised fund (DAF)?
Donor-advised funds (DAFs) have gained prominence as a versatile and tax-savvy solution for those seeking to optimize their charitable giving while navigating the ever-evolving tax landscape. A DAF is essentially a charitable investment account that allows individuals to contribute, receive an immediate tax deduction, and then recommend grants from their fund to their chosen charitable organizations over time. Think of it as having a personal philanthropic savings account. When it comes to bunching charitable contributions, DAFs can offer an effective strategy that marries flexibility with tax benefits.
How do donor-advised funds work?
In a single year, you contribute a substantial sum of money to a DAF creating an immediate tax deduction. This is often a “bunched” charitable contribution. Once the DAF is funded, you retain the authority to recommend grants to your chosen charitable organization over time, ensuring that your philanthropic goals are met. Meanwhile, you have already realized the upfront tax benefits.
For instance, if your annual charitable giving traditionally amounts to $10,000, you may still benefit from the standard deduction. By contributing $30,000 (or 3 years’ worth of charitable contributions) to a DAF in a single year, you can itemize your deduction in the first year. This would allow you to utilize the standard deduction for the following two years and achieve a greater tax benefit over the 3-year period. In addition, you can utilize your DAF to support charities as planned over the 3-year period.
What are theIR advantages?
The advantages of utilizing a DAF for bunching are multi-fold. Not only do you receive immediate tax benefits, but you also enjoy the convenience of streamlining your giving from one central account. Moreover, DAFs allow you to invest the funds, potentially growing your charitable assets over time. This unique combination of flexibility, control, and tax optimization makes DAFs a versatile tool. With this said, it is important to note that this strategy is for after-tax charitable contributions. In addition, it is separate from Qualified Charitable Distributions (QCDs) from your IRA. QCDs cannot be made to a DAF.
DAFs are not for everyone. It is important to consult with your tax advisor or CPA to determine if a DAF would be beneficial to your situation. Their expertise can help you appropriately tailor this approach to your specific financial situation, allowing you to achieve a greater tax benefit while supporting non-profits that are close to your heart.
Author: Alexis Hudgins, CFP® | Financial Planning Advisor
Written: October 21, 2023