Learn how to incorporate a donor advised fund into your clients’ portfolios to reduce tax drag.
By Mariah Brook, Director of Gift Planning
In order to avoid a “tax drag” it's important to periodically rebalance investment portfolios. This is a basic principle of today’s investment practices and often helps to bring the investment mix back into alignment with the target allocation.
Unfortunately, over time the resulting capital gains tax from rebalancing a non-qualified portfolio adds significant tax drag to the long-term performance. If an investor lives in a state with its own capital gains tax, that tax drag is even greater.
Fortunately, there is a simple strategy that can significantly reduce or even eliminate tax drag – a donor advised fund (DAF).
The vast majority of American households give back to their communities every year. Most of us are in the habit of giving cash to our favorite causes, but there may be a smarter way to give. Gifts of appreciated securities are often a much more financially efficient gift than cash. When combined with a portfolio rebalance, the benefits increase even more.
Kelly’s Investment Story
Let’s look at a hypothetical example to show how it works.
Kelly’s non-qualified investment portfolio is currently valued at $1 million. The target allocation for the portfolio is 60% equities / 40% fixed income, but it currently sits at 65% equities / 35% fixed income. This means Kelly needs to convert $50,000 of equities to fixed income.
She usually donates about $25,000 each year in the form of cash, but this year, her wealth advisor recommended that she consider donating highly-appreciated securities instead of cash in order to make her portfolio rebalancing more tax-efficient.
At her financial advisor's suggestion, Kelly decides to be more strategic with her giving plan.
Kelly contributes $25,000 of highly appreciated stock from her investment portfolio to a DAF. This gift will result in a $25,000 income tax deduction and zero capital gains tax on the donated shares.
She sells another $25,000 to re-invest in fixed income assets. The basis of the stock is zero – resulting in capital gains tax on the entire $25,000. The charitable deduction from the gift of stock essentially off-sets the capital gains tax and virtually eliminates any tax drag this year.
Kelly takes the $25,000 in cash that she planned to donate and adds it to her investment portfolio to purchase the remaining $25,000 of fixed income assets - bringing the balance back up to $1 million.
|Rebalance with Gift of Cash||Rebalance with Gift of Securities|
|Sell $50,000 Securities to Reinvest||Sell $25,000 Securities to Reinvest|
|Donate $25,000 in Cash||Donate $25,000 in Securities|
|Capital Gains Tax: $50,000 x 20% = $10,000||Capital Gains Tax: $25,000 x 20% = $5,000|
|Add $25,000 Cash to portfolio|
Charitable deduction: $25,000 x 35% = $8,750 tax savings
Total tax due: $1,250
Charitable Deduction: $25,000 x 35% = $8,750 tax savings
Total tax due: $0
You may be wondering why Kelly chose to use a DAF rather than donating stock directly to her favorite causes. A DAF at the Saint Paul & Minnesota Foundation accepts a variety of assets, including securities. Those securities are immediately sold and reinvested into a diversified portfolio. This means Kelly can then recommend grants from her fund to her favorite organizations when she is ready.
She will receive one gift receipt for her gift of securities, rather than multiple receipts if she were to make separate gifts to a variety of causes. This simplifies her record keeping. Kelly’s fund is ready to receive future gifts of securities or other assets she wishes to use for charitable giving. This is just one of the many benefits to establishing a DAF.
Benefits of Partnering with the Foundation
Partnering with us also gives your clients access to a host of other benefits, including:
A dedicated philanthropic advisor to help define, plan and fulfill their philanthropic desires
Recommendations about the nonprofits and causes that align with their values and desired impact
Insights to help them achieve the most impact with their charitable dollars
A variety of strong investment options to help them plan for both today and the future
Tools to guide individuals and families in defining, setting and executing a bold giving vision
Donor-only events, with opportunities to hear and learn about local and emerging topics
An online donor portal, making it easy to access information and recommend grants
The Saint Paul & Minnesota Foundation does not provide tax, legal or accounting advice. Please consult your own tax, legal and accounting advisors regarding your individual situation before engaging in any transaction.
Now is the time to talk to your clients about options related to required minimum distribution taxation with a qualified charitable distribution.Learn More
Learn why attorney Abby Leach Schumaker partners with the Saint Paul & Minnesota Foundation to help her clients fulfill their giving goals.Read Abby's story
Learn how investment advisor and senior financial planner Fatima Iqbal uses Islamic guidelines to assist Muslim clients, and how the Foundation partners with the Muslim American Society of Minnesota.Learn about the changes
You can help your clients make the most out of their gifts with the recent changes to the rules on charitable giving.Learn about the changes