How to Make Your Charitable Giving More Tax-Efficient
For those with charitable hearts, donating to preferred causes is about making an impact on organizations and ultimately improving a community. Whether it’s your church endowment, a connection to your old school, a local animal shelter, or a disaster relief organization, giving from your resources could be a very rewarding act of generosity.
What many donors don’t realize is that how you give could be just as important as what you give. While writing a check is usually the easiest approach, there are other charitable giving strategies that may allow you to support the organizations that matter to you in a more tax-efficient way. In some cases, these strategies could reduce taxes, avoid unnecessary capital gains, or help you maximize the amount ultimately available for charitable purposes.
The right approach depends on your individual circumstances, including your income, investment holdings, stage of life, and charitable goals. Understanding the available options could help you make informed decisions and ensure your giving is coordinated with your comprehensive financial plan.
In this article, we’ll explore three commonly used charitable giving strategies: donor-advised funds, gifts of appreciated securities, and qualified charitable distributions from IRAs. Each works differently, but all share a common goal: helping you make a greater impact with the resources you’ve been entrusted to manage.
Donor-Advised Funds: Flexibility for Thoughtful Giving
A donor-advised fund (DAF) is one of the most popular charitable giving vehicles available today, because it combines flexibility, simplicity, and potential tax benefits.
A DAF works much like a charitable investment account and is often established through a community foundation. After opening an account, you make a contribution, receive a potential tax deduction in the year of the contribution, and then recommend grants to qualified charities over time. While the assets remain in the fund, they could be invested and have the opportunity to grow free of tax, potentially increasing the amount ultimately available for your favorite causes.
One of the unique advantages of a donor-advised fund is that it allows you to separate the timing of the tax deduction from the timing of your charitable gifts. For example, you might contribute to a DAF during a year in which your income is unusually high but distribute grants to your favorite charities over the subsequent months or years, with no required timeline for giving it all away.
Donor-advised funds are often worth considering during years where you encounter significant financial events, such as:
- the sale of a business with a lump sum settlement,
- the receipt of a large bonus,
- the exercise of stock-based compensation,
- a year with unusually high income, or
- the sale of highly appreciated investments.
In these situations, a DAF may help create a larger charitable deduction (bunching deductions above the standard deduction) in a year when it could be particularly valuable from a tax perspective.
Beyond tax considerations, many donors appreciate the organizational benefits of DAFs. Rather than tracking receipts and making separate donations to multiple charities throughout the year, donors could contribute to the fund and then manage their charitable grants from a single account. Some families also use donor-advised funds as a way to mentor children or grandchildren about charitable priorities and long-held family values.
Most importantly, donor-advised funds could help donors be more intentional about their giving. By setting aside funds dedicated to charitable purposes, many people find they are better able to create strategic giving plans and support the causes that matter to them.
While a donor-advised fund could be a powerful tool, it is not the right fit for every situation. The decision should be evaluated in the context of your overall financial plan, tax situation, and charitable goals, ideally, in coordination with your financial advisor and tax professional.
Gifting Appreciated Securities: A Tax-Efficient Alternative to Cash Gifts
Many charitable gifts are made with cash but for investors, appreciated securities could often be one of the most efficient assets to give.
Appreciated securities are investments, such as stocks, mutual funds, or exchange-traded funds (ETFs), that have increased in value since they were purchased. Rather than selling these investments and donating the proceeds, donors may be able to transfer the securities directly to a qualified 501(c)(3) organization.
When a gift of appreciated securities is made directly to charity, the donor may be eligible for a charitable deduction, based on the fair market value of the investment. In addition, because the securities are donated rather than sold, the donor may be able to avoid capital gains taxes on the appreciation.
For example, imagine you purchased stock years ago for $10,000, and it is now worth $25,000. If you sold the stock first, you could owe capital gains tax on the $15,000 increase in value. By donating the shares directly to charity, the charity receives the full $25,000 value of the gift, and you may avoid recognizing the capital gain altogether.
This strategy could be particularly attractive for investors who have:
- investments that have appreciated significantly over time,
- concentrated stock positions they would like to reduce,
- a desire to rebalance or reallocate their portfolio, or
- ongoing charitable giving goals.
In many cases, donating appreciated securities allows donors to support charitable organizations without impacting their cash flow as significantly as a large cash gift might. Some donors even choose to donate appreciated shares and then use cash they would have otherwise gifted to reinvest in a more diversified portfolio.
The greatest benefit of this strategy is not simply tax savings. By reducing taxes that might otherwise be paid when an investment is sold, more of the asset’s value could potentially be directed toward the charitable causes you care about most. This could increase the impact of your giving while remaining aligned with your wider financial goals.
As with any charitable planning strategy, it is important to coordinate with your financial advisor and tax professional to determine whether gifting appreciated securities is appropriate for your situation and to ensure the transfer is handled correctly.
Qualified Charitable Distributions: Giving Directly from an IRA
For charitably-inclined retirees, a Qualified Charitable Distribution (QCD) could be one of the most tax-efficient ways to support a favorite charity.
A QCD allows eligible individuals to transfer funds directly from an IRA to a qualified charitable organization. Unlike a typical IRA withdrawal, an investor can exclude the amount distributed through a QCD from taxable income, provided that he or she meets specific IRS requirements.
This distinction could be significant. Normally, distributions from traditional IRAs are included in taxable income. With a QCD, the funds go directly from the IRA to the charity, allowing the donor to support causes they care about without increasing their taxable income by the amount of the gift.
QCDs are particularly attractive for retirees who are already giving to charity on a regular basis. They could also be beneficial for individuals who are required to take annual Required Minimum Distributions (RMDs) from their IRAs. A QCD could satisfy all or part of an RMD while directing those dollars to charitable organizations instead of retaining them as personal income.
In addition to reducing taxable income, a lower reported income may provide benefits in other areas of a retiree’s financial life. Depending on the situation, it may help reduce the impact of income-related Medicare premium surcharges or the taxation of Social Security benefits.
A QCD may be especially worth considering if you:
- are age 70½ or older and give regularly to charity,
- have significant assets in traditional IRAs,
- are taking Required Minimum Distributions,
- do not itemize deductions on your tax return, and/or
- are looking for ways to manage taxable income in retirement.
Like the other strategies discussed in this article, the primary goal is not simply tax savings. Rather, a QCD may allow more of your resources to be directed toward the organizations and missions you care about most. By giving directly from an IRA, eligible retirees could often support charitable causes in a manner that is both impactful and tax efficient.
Because QCDs are subject to specific IRS rules and annual limits, it is important to coordinate with your financial advisor and tax professional before initiating a distribution. When used appropriately, however, a QCD could be a valuable tool for integrating charitable giving into a broader retirement and financial planning strategy.
Putting Your Giving Strategy in Context
There is no single “best” charitable giving strategy. The right approach depends on a variety of factors, including your financial situation, the types of assets you own, your stage of life, and the causes you hope to support.
For some individuals, a donor-advised fund may provide flexibility and help organize future giving. For others, donating appreciated securities may allow more of a gift’s value to reach the intended charity. Retirees may find that qualified charitable distributions offer a particularly effective way to integrate charitable giving with their retirement income plan.
Giving from your asset base may also allow you to preserve cash you might otherwise have donated, potentially improving your available cash flow.
While each of these strategies could provide potential tax benefits, there are differences in deductibility limits (for example, cash versus appreciated securities). It is best to work with your advisory team to determine a prudent approach to your gifting strategy.
Thoughtful charitable planning could help you direct more resources toward the organizations and missions that matter most to you, potentially increasing the impact of your generosity. As with most financial decisions, charitable giving is most effective when considered within the context of your overall financial plan. Working with your financial advisor and tax professional could help ensure your giving strategy aligns with both your charitable goals and your long-term financial objectives.
Ultimately, charitable giving is about more than tax efficiency. It’s about using your resources in a way that reflects your values and creates a meaningful impact for the people, communities, and causes you care about most.
