Summary:
Saving taxes is one of those statements that catches everyone’s attention. Let us become aware of a tax saving strategy that most of us have not paid attention to. I am referring to Donor Advised Funds (DAF) [1]. If there is a need to use this tax saving strategy and if it is done right, it can maximize your charitable giving and at the same time minimize your taxable income. More on this later. In the next ten minutes you can find out if this is right for you and if any of your financial goals could be achieved utilizing this tax-saving strategy. It is a four-step process.
The advantage of this strategy is twofold. You get a little tax savings for the year you donate your funds to a DAF account. A qualifying DAF account could be opened with any of your regular investment organizations. Few DAF account operators and their websites are:
[1] Vanguard Charitable, [2] Schwab Charitable, [3] Fidelity Charitable, and a few more. Your favorite investment organization / brokerage account will have a 501(c)(3) Charitable organization to manage DAF accounts as per IRS guidelines.
Carefully evaluate your DAF fund holding organization for any fees (Annual or Admin or Investment or Maintenance) they may have. Also validate the minimum initial and additional contributions they allow.
Points to Note:
Couple of points worth noting before venturing into DAF as a strategy for tax saving:
⁑1⁑ Once money is moved to this account is irrevocable and is 100% mandatory for you to donate those funds to an IRS approved charitable organization anytime in the future, without an expiry date. You can take the tax-reduction advantage for the same year you donated. This is why this should be done under the guidance of your tax planner or CPA. Before you decide, identify if this is the right tax-saving strategy for your circumstances, as there are a few alternatives that exist, if used can provide some relief for your taxes and those listed in the “Alternate Tax-saving Strategies” section below.
⁑2⁑ You will not get a 1:1 tax break. Meaning in a year you put $10,000 as gift, you may get a fraction percent of that gifted amount as your tax saving/reduction. The formula is complex and is based upon multiple variables like a) Estimated donation amount, b) Your filing status, c) Marginal Federal income tax rate and d) Sum of your all-other itemized federal tax deductions for that year.
Important Note: You will first make the gift between Jan 1 and Dec 31. But the above “item d)”, you will only know earlier next year in the tax filing season. This is the exact reason you should strategize this with your tax professional in the last two months of your tax year.
An approximate DAF Tax Savings calculator could be used from here.
⁑3⁑ Most crucial point is, you may establish your “Charity-Giving” DAF account today or any time during this year and contribute to it any time before December 31st of that year to reap the donation benefits in the next tax filing season. Funding of this account could be done any time you want.
⁑4⁑ While opening a DAF account no minimum balance is required and no minimum mandatory contributions are required by IRS once you open a DAF account. However, the DAF operating entity may have some restrictions of their own. You may contribute this year and then do it again after three years. Keep your funds invested properly so that they grow.
⁑5⁑ You have the flexibility to invest your “charity gifted funds” and grow them as you desire and there are no contribution limits from IRS. There may be some from your DAF operator.
⁑6⁑ Your charitable funds can grow tax-free indefinitely. That way if you invest the funds in your DAF account properly with the guidance of good financial advice, the funds can grow indefinitely. You may put in your Trust or Will to which charity or charities it should be distributed after your passing.
⁑7⁑ If DAF strategy is properly strategized; more money could be available down the road to support your favorite charitable organization. You can grow your charitable funds tax free in your DAF account and you can decide when and to which of your favorite charity or charities the money goes. Upon your decision and direction, the DAF account holding entity will directly pay to your IRS-qualified charity within the United States.
⁑8⁑ Apart from cash you may contribute stocks also. Long term (assets held for more than one year) appreciated stocks are used to save or reduce or eliminate capital gains tax for that Tax year, if that is what you are looking for. This will result in a tax reduction and some tax savings for you in that year.
⁑9⁑ You can also donate “non-publicly traded assets” like bonds, mutual funds, IRAs, 401Ks, Private company stocks, Cryptocurrencies, Life Insurance, and few more. For official definition refer to IRS page here.
Alternate Tax-saving Strategies:
Apart from DAF, a W2 employee has few other options to save on taxes and those are listed below:
⁑1⁑ Contribute to your Health Saving Account (HSA). IRS guidelines on the limit of contribution changes yearly based upon your age and the second requirement is, you must be enrolled in a high deductible HSA eligible health plan. To find the exact limits for a given year, make a web search with the words “HSA contribution limits”. If you qualify, this is the best strategy and upon funding your HSA with the maximum limit, it will result in the best tax saving for that year. This is the best strategy to save on taxes for this year and as well as for the previous year, as you can still contribute till April 15th of this year, for the previous year’s taxes.
⁑2⁑ Make or increase your 401K Retirement Plan contributions. IRS guidelines on the limits on this type of contribution change yearly based upon your age and AGI (Adjusted Gross Income). Make a web search for these words “401k retirement plan contribution limits” to find the exact amount you can put for that year for maximum tax-saving. This is a good strategy to save taxes for this year.
⁑3⁑ Make a Backdoor Roth IRA, which is another strategy used by high-income earners to contribute to a Roth IRA despite the IRS-imposed income limits. In Roth IRA, the tax savings are not immediately realized, as you will be putting your after-tax income into ROTH. These investments grow tax free, and you will NOT pay taxes in the future when you withdraw the funds upon your legal retirement age. Best used in conditions where you want to a) Bypass income limits, b) Tax-free retirement funds growth and c) in the Estate Planning.
Note, the negative aspect of this strategy is you pay double taxes on it (first, your contributions are from your after-tax money; second, you will pay tax again, when you convert from Traditional IRA to Roth.)
The benefit comes as your funds grow tax-differed and you do not have to pay taxes on it when you withdraw upon your retirement.
Contact your CPA or Tax Planning professional or retirement funds holding entity for details.
⁑4⁑ 529 plans are tax-advantaged accounts designed for saving for a qualified education expense of “your beneficiary” and gives you immediate tax benefits to your contributions in this plan. Unlike the above strategies, there are no yearly contribution limits set by the IRS for 529 plans. However, each state has its own specific aggregate contribution limit for each 529 accounts [1], [2]. For the current year max per donor, per beneficiary, search the web.
⁑5⁑ “Tax-loss harvesting” is another strategy utilized to lower current taxes. Selling securities involves capital gain tax on the profits. When you sell on a negative (loss), you get an adjustment for a limited amount for a given tax year. In this strategy you sell an investment at a loss with the goal to offset taxes owed on an investment sold at a profit or even taxes owed on personal W2 income.
⁑6⁑ It is worth noting here that only the medical expenses portion that exceeds 7.5% of your AGI (Adjusted Gross Income) [1] becomes tax deductible.
⁑7⁑ Another strategy is to give money/assets as a gift (not DAF) to your loved ones, which also have potential tax-savings for you for that year. This strategy is applied for wealth inheritance. Two concepts and limits need to be understood for this tax-strategy to work for you:
(a) “The annual gift tax exclusion” and
(b) “The lifetime gift tax exemption”.
Depending upon how you are filing your taxes, this “limit (a)” may change from year to year. To find the “limit (a)” best is to search the web. As far as you are under these two limits, you certainly can make tax-free gifts without incurring any tax liability. The recipient of a gift if above a certain limit, must show this as gift received in their tax filing for the year they received the gift.
“Limit (b)” was updated by the Tax Cuts and Jobs Act of 2017 (TCJA) and the current lifetime gift tax exemption limit in 2024 [1] stands at $13.61 million per person (or $27.22 million for a married couple). This amount is the cumulative maximum gifts you can give during your lifetime without incurring any gift tax [1]. TCJA clause for gift is set to expire at the end of 2025, where the gift tax exemption limit will fall back to $11.2 million from 22.4 as the original pre-TCJA value.
Summary & Conclusions:
Once you understand what DAF and other tax saving strategies are, let us visualize two specific scenarios under DAF as a takeaway.
Scenario one, only applies to high income individuals (HII), who have maxed out all tax saving strategy limits as discussed above, then this scenario may make sense. Imagine as a HII how much tax you must have paid in taxes for the last say 5 or 10 years. Now imagine, if you were doing DAF for the last few years and constantly saving your charitable funds and getting a minor tax saving. Now imagine the aggressive compound growth of your gifted money under your control, after say 10 years in your DAF account. It will be substantial. You may give this money to a charitable cause of your choice, at your discretion and direction.
Scenario two, imagine you along with a few (5 to 10) of your high-income individual friends, relatives or similar thinking individuals pooling this same DAF idea and all these individuals in parallel saving in an DAF account for the last few years. Now imagine how much that gifted money has grown in the respective individual DAF accounts with an aggressive investment strategy. It could be multifold. Because of the similar thinking your group has, your group’s combined philanthropic power is phenomenal, which will not be possible by any ordinary individual, alone.
You may now pool your group to open an IRS 501(c)(3) genuine charitable organization/foundation, with whatever philanthropic collective vision your group has, be on the charitable organization’s board, and decide to make a real difference to the philanthropic cause you all agree with.
Now picture this: Ten high-income individuals, all part of your extended family, sharing the same last name. Over the past decade, they’ve diligently grown their respective saving into their own DAF funds. The possibilities are awe-inspiring! Imagine sowing the seeds for your very own IRS-approved charitable organization or a philanthropic foundation that bears your family’s name and legacy, which won’t end here. Even beyond your time on this earth, your impact will continue to ripple through generations to come.
Hopefully, the reading enlightened your imagination and motivated you towards making this world a better place for those coming after us!
About The Author:
Asad Syed is a graduate of Mathematics, Applied Mathematics and Statistics. His experience spans in Security Architecture, Security Operation Management, Digital Investigations & Forensics, Crisis & Threat Simulation, GRC Management, Threat Hunting, Cybersecurity Emerging Trends & Threat Mitigation, Database Security, Identity & Access Management, and Identity Federation. His interests are in the application of newer technologies, to enhance the output performance of technologies with which he is working. He is a writer, teacher, and cybersecurity evangelist, who has worked for multiple fortune five hundred companies and currently providing cybersecurity consulting to the upstream operations of the oil and gas industry. Reach him via Asad at ASyed dot com. ■
