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Sarah’s Questions: Is a Donor Advised Fund or a Qualified Charitable Distribution better for me?

Sarah’s Questions: Is a Donor Advised Fund or a Qualified Charitable Distribution better for me?

By Michael Lynch CFP®

My client Sarah (name changed for obvious reasons) is a personal finance enthusiast.  As I shared in my first “Ask Sarah” post, she reads broadly in the field and graciously sends me clippings with sophisticated questions that send me sprinting to my spreadsheets and deep internet research to address. A little more background is in order.  She hates bonds, loves stocks, detests taxes, abhors fees of any kind and, due a lifetime of frugal living, has far more money than she will ever spend.  At 72, the after-tax portion of her Required Minimum Distributions (RMDs) go straight into her non-qualified investment account which naturally is invested entirely in equities of US companies.  To help people simplify their finances to make it big, I will periodically address Sarah’s questions.

Sarah recently asked me which was better for her, creating and funding a Donor Advised Fund (DAF) or a strategy relying on Qualified Charitable Distributions (QCD)? She of course wanted to make a double play—funding a DAF with a QCD—but that is too good to be allowed by the IRS.

Some definitions are needed.  A donor advised fund is an investment account, held at a financial institution, that allows a person to make a substantial gift or gifts, take the full tax deduction in the year the cash gift is deposited, and then advise on subsequent distributions to public charities.  I think of them as a charitable foundation for the middle class.  The key is the deduction is taken up front, not when the distributions actually do their good.  These allow for a bunching of charitable contributions from a tax perspective and became useful and popular when the now current tax code increased standard deductions and restricted the amount of state and local taxes and could be deducted to $10,000. 

The contribution reduces taxable income not adjusted gross income.  I find these to be excellent tools for people who experience a large windfall, such as a sale of a business or exercising of a large pool of stock options. In a year of high income and therefore taxation, they can reduce Uncle Sam’s cut and create a pool from which to make the world a better place in the future. 

A Qualified Charitable Deductions (QCD) is a direct payment from an IRA to a qualified public charity.  A person must have reached 70.5.  She can send $100,000 or the Required Minimum Distribution (RMD) whichever is less.  A QCD reduces a person’s Adjusted Gross Income (AGI).  This is both  beneficial and detrimental.  First, you don’t need to itemize to benefit.  Second, AGI drives many bad things for retirees on a tax return, from increasing how much Social Security is subject to taxation to how much you will pay for Medicare Parts B and D. 

For Sarah, this was an easy call. The QCD is preferable since she takes the standard deduction and is in the penalty zone for Medicare.  The simple principle that you can use to make it big here is this,  for one-time taxable events, a Donor Advised Fund can be a financial home run.  You get a deduction in a year in which you will pay high tax rates and fund charities with no further deductions in lower tax years.  For people like Sarah who are over 70.5 and expect to have ongoing and increasing tax and Medicare bills, a Qualified Charitable Distribution is likely to be the better choice. 

 

Michael Lynch CFP® is a financial planner at Barnum Financial Group in Shelton, CT.  His book “Keep It Simple, Make it Big: Money Management for Meaningful Life,” offers simple strategies for financial success.  His writings can be found at www.michaelwlynch.com

 

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. Barnum Financial Group.  6 Corporate Drive, Shelton, CT 06484, Tel: (203) 513-6000. CRN202302-278810