We sat down with Adrian Colarusso, an advisor at Target Rock Wealth Management, to answer the top questions that people had around charitable giving.
In addition to being a financial advisor, Adrian is actively involved in a number of charitable organizations. He serves on two boards for local non-profits: Arm In Arm, a Trenton-based non-profit that helps county residents in need of food security, housing stability and job training, and Friends of Herrontown Woods, the stewards of a local nature preserve. He has tremendous expertise when it comes to charitable giving and how to do so in a tax-efficient way. Here are his answers to the burning questions that people had around giving.
Question: How do I know if I should consider more significant charitable giving?
Answer:
Great question. Charitable giving is for those who basic needs are met, but also who have gotten the consumption goal post to stop moving. Of course, high-income people give more to charity, but at any level of wealth or income, there is always something more you can spend your money on for yourself. Therefore, re-orienting your goals toward impactful charitable giving may help you stay disciplined on your wealth building journey, and not become hostage to material lifestyle creep as your income and wealth grows.
If you are interested in benchmarking your giving, here’s an article from Philanthropy Round Table: Statistics on U.S. Generosity – Philanthropy Roundtable. About 2/3 of US households donate to charity, typically about 2-5% of income.
People give to charity for all kinds of reasons. There are over a million non-profit organizations in the US that you can support, for causes of all kinds. And if you are frustrated with efficacy of the political process to shape the world to your liking, non-profits are an impactful alternative. So, look around for problems you care about solving, find a non-profit that seems to be making headway, do some research and volunteer with them if possible, and give them your financial support. The government can’t do everything, which is why it writes the tax code to incentivize us to take action ourselves.
Question: How does a financial advisor help you with giving to charity?
Answer:
I’d say there are two main aspects they help with:
- Feeling confident about how much to give, in a way that’s aligned with your values and won’t compromise other goals, and
- Doing so as tax-efficiently as possible.
When you work with an advisor who does holistic wealth planning, they can look at your entire wealth picture while getting to know you and the “Big Why” behind your giving. They should help you identify where the money should come from – whether from income, savings, or, when possible, appreciated assets. They can also help with longer-term planning of your giving, which can help get the most lifetime tax benefit. Lastly, they may help you come up with an estate plan, where you could leave a portion of your assets to charity upon your death.
Question: Is there a best donation strategy to maximize tax benefits?
Answer:
If you find yourself in a tax year where these three things are true – and charitable giving is important to you – you should pounce on the opportunity to open a Donor Advised Fund.
- You have an appreciated asset (like a stock, but not necessarily) on which you would owe significant capital gains taxes if you were to sell it. Bonus points if this asset represents a concentrated risk on your balance sheet (i.e. it’s a single company and not a diversified fund).
- You are in a relatively high tax bracket. Maybe you had an income windfall this year, and you are looking for income tax deductions.
- You itemize deductions on your tax return anyway, even without charitable donations. Most commonly, those who itemize deductions do so because they live in a state with income tax and/or pay local property taxes (which are deductible up to $10,000 for married couples filing jointly) and they pay mortgage interest that brings them over the standard deduction threshold ($27,700 for MFJ in 2023).
If you contribute your appreciated stock to the Donor Advised Fund, you’ll get: 1) a dollar for dollar write-off against your taxable income for the market value of the stock, saving you the marginal rate on both federal and state income taxes, 2) relief from the capital gains taxes you would have had to pay on the stock if you had sold it, and 3) potentially several years’ worth of charitable gifts stockpiled in a war chest to disburse at your leisure to the causes you care most about.
For top bracket people in high-tax jurisdictions, with highly appreciated assets, their “cost of generosity” could be dimes on the dollar compared to a non-itemizer giving cash.
The major brokerages have easy-to-use interfaces to make grants from your Donor Advised Fund on their platform. Every time your friend is running a marathon for charity, you can support the cause generously with your earmarked funding. And don’t forget – you can use Donor Advised Funds to contribute to your church, temple, mosque, alma mater, and often your neighborhood school’s PTA.
Question: Can you give more details on the Donor Advised Fund? Is it a cash fund? Or an investment fund? How do you open one?
Answer:
A Donor Advised Fund (DAF) is an investment account earmarked for charitable giving. Once you put assets into a DAF, you can’t take them out to spend them on yourself; they must be disbursed to a 501c3 organization. The DAF can be invested in a menu of options ranging from money market funds (cash-like) to an all-stock portfolio. It can be funded with cash or appreciated assets like stocks.
Opening an account is easy with any of the major brokerages (Schwab, Fidelity, Vanguard and others). What’s more nuanced is your strategy behind it. The main reason to open a DAF is if you want to create a large tax-write off in the current tax year, but take your time disbursing the assets of your favorite charities.
You might have an urgency to stockpile future charitable giving for a few reasons: Maybe this is a particularly high-income year for you, and you are sitting on a large capital gain in a risky single stock. You wouldn’t want to contribute cash to a DAF if you have appreciated stocks to contribute instead. After all, you could always use your cash to buy your stock on the open market, if that makes sense for your situation.
Since non-profits aren’t subject to capital gains taxes, you can dish your most appreciated shares to your DAF, and then the DAF will automatically sell those shares and put the proceeds in a diversified portfolio without tax friction. And then, of course, you’ll get the income tax deduction equal to the market value of the shares contributed.
If you don’t have appreciated stock to contribute, but do have excess cash, you might use a DAF to execute a strategy called “bunching”. This is for people who typically don’t itemize their deductions on their tax returns because their main itemizations – usually state and local taxes plus mortgage interest – is less than the standard deduction. Maybe you are about to move from California to Texas – in that case, consider bunching in the last year you live in California.
You’ll “bunch” several years of charitable giving into the current year by contributing to the DAF, so in the current year, you will itemize with one big fat deduction that will exceed the standard deduction. Then in future years, you’ll take the standard deduction, and not have to budget for any charitable giving, because you can just disburse it from the war chest you established in your DAF. Meanwhile, hopefully, the investments in the DAF are providing a tailwind to your giving with positive returns (although of course investing involves risk).
It’s something tricky to wrap your head around all the possibilities, so we recommend working with an advisor knowledgeable in this space to help you put a game plan together.
Question: Is there something I should be doing beyond itemizing my donations?
Answer:
If you are itemizing deductions on your tax return anyway (i.e. your state and local taxes + mortgage interest exceeds the standard deduction, usually), then you should be fine simply itemizing your donations. However, if you have appreciated securities in a taxable brokerage account, you should donate those to charity instead of your cash, and use your cash to re-purchase the securities you donated (assuming you still want to own them – but that’s a whole other conversation about endowment bias and sensible portfolio construction). You might find it easier to contribute the shares to a Donor Advised Fund first, and then take your time to disburse the funds to charities, instead of gifting the securities directly to the non-profits.
If you are NOT itemizing deductions on your tax returns anyway (i.e. you are in a no-income tax state and don’t pay a mortgage on a home, usually), then you should consider “bunching” your charitable giving into a single tax year (if you have the cash and/or assets available). This way, you can itemize deductions in the year you contribute to the DAF and get a large income tax write off, and then in the subsequent years, you can take the standard deduction, while still supporting your charities by disbursing dollars you’ve already deducted in year one. Here’s an article from Schwab: Bunching charitable contributions | Schwab Charitable Donor-Advised Fund | Schwab Charitable
I’ve come across people who were donating to charity thinking it was tax deductible, but in fact there was no tax benefit to their giving because they were under the standard deduction.
Question: Can I use donations to offset investment income?
Answer:
If you are itemizing deductions on your tax return, then yes, charitable donations offset investment income just like any other form of income that contributes to your AGI.
Target Rock Wealth Management LLC is an Investment Advisor registered with the State of New York. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy, or the completeness of, any description of securities, markets or developments mentioned. The views expressed within are for commentary purposes and are based on only cursory considerations for any individual personal, financial, legal, or tax circumstances. As such, the information contained herein is not intended to be personal legal, investment, or tax advice. Nothing herein should be relied upon as such, and there is no guarantee any claims made will come to pass. We recommend you speak with your CPA or tax professional