Afford Anything - PSA Thursday - Your Complete Guide to Donor Advised Funds

Episode Date: June 19, 2020

For more information, go to https://affordanything.com/tag/psa-thursday Learn more about your ad choices. Visit podcastchoices.com/adchoices

Welcome to PSA Thursday, a weekly bonus segment of the Afford Anything podcast in which we talk about how to manage money, work, and life in the special circumstances of the year 2020. These PSA Thursday episodes are bare bones stripped down versions of the podcast. There's no intro music, no outro music, no ads. They're typically much shorter shows. And we deep dive into one specific topic. So last week, for example, we covered student loans and how the CARES Act, which was passed. at the beginning of the coronavirus pandemic, how the CARES Act impacts student loans. So tune into last week's episode for that.

Today, we're going to be talking about donor advised funds. What are they? What are the benefits to opening one? And how would you go about opening one if you wanted to? Let's begin. A donor advised fund is a charitable giving account. Some people call it a philanthropic fund or a giving vehicle, but it is an account that you open specifically for the purpose of giving the money inside of that account to,

charity. So the money that is put inside of a donor advised fund technically is no longer yours. The minute that you put money inside of a donor advised fund, that money now belongs to charity. But you get to manage that money and grow that money. You get to manage and grow the investments until you designate which specific nonprofits you want that money to go to. In that regard, many people compare having a donor advised fund to starting a charitable fund. foundation or establishing a charitable trust. Both foundations and trusts are very different vehicles. They are certainly not the same as a donor advised fund. And donor advised funds are the fastest growing funds in popularity in terms of charitable giving because they're relatively

much simpler and easier to open. As compared with starting a trust or establishing a foundation, creating a donor advised fund is, it's simple, it's easy, it's very accessible to middle-class givers. And that's a huge part of the reason why they've exploded in popularity in the last few years. So here is how it works. First, you would open a donor-advised fund with any major brokerage or financial institution that has the option of offering donor-advised funds. So in today's podcast episode, we're going to focus on the big three brokerages. Vanguard, Schwab, and Fidelity, those are considered the big. big three discount brokerages because all of them offer index funds for regular investors, for people

who want to open IRAs or taxable brokerage accounts, all three of those offer index funds that are among the lowest priced on the market. And so for that reason, Vanguard Schwab and Fidelity have all developed a reputation as being those big three discount brokerages in terms of if you're going to have your account somewhere, if you want to make sure that you are not paying too much in fees. Those three are the three major established trusted players in the discount investment space or the low-cost investment space. So let's go back to how a donor advised fund works. You would step one, open a donor advised fund at one of those three institutions or any other institution that you prefer. Once you've opened this account, you would

select a name for your donor-advised fund. So for example, you could name it the Jones family charitable account. Or you could name it the Rover the Dog Memorial Philanthropic Fund. So in the same way, if you were to open a foundation, you would give that foundation a name. In that same spirit, you also give your donor advised fund a name. And it doesn't stop there after you give it a name. And after you open and establish the account, you will donate assets into a donor and advised fund. And when I say donate assets, you can contribute almost any type of asset that you want. You can contribute cash. You can contribute publicly traded stocks, bonds, mutual funds, index funds, cryptocurrency. You can contribute your stocks or your interest in a

privately held company, such as a private C corp or a private S corp. You can contribute pre-IPO shares. You can contribute restricted stock or private equity or life insurance or oil and gas royalty interests. There's a lot of different types of assets that you are eligible to contribute. into a donor advised fund. For example, when I opened mine, I contributed index funds directly into it. And I'll talk more in a few minutes about why I chose to do that. But there's a big tax advantage to contributing index funds and other types of investments that have long-term appreciation behind them. We'll talk about that in a second. But first, let's go back to how does it work? So you open the account, you give it a name, you donate assets into the account, and then you decide how those assets

should be invested. So most funds have asset allocation pools, such as conservative, moderate, growth, and you can decide based on the time in which you expect to give that money to a particular designated charity, you know, you can decide what type of asset allocation pool is appropriate for the timeline to the ultimate release of those funds to a given nonprofit. So for example, if you think that you're going to give the funds inside of your donor advised fund, if you think that you are going to start granting out that money this year or next year, then you would want to keep it probably in something very conservative. Maybe cash, cash equivalence, a money market account, maybe some very, very, very conservative funds. That's the way that you would treat it because of its timeline to granting. By contrast, if you plan on keeping those assets there for five years or 10 years, or if you aren't committed to any particular grant timeline at all, and you're simply willing to give the grant when the markets are up, whenever that may be, then you can invest it a little bit more aggressively.

You could put it into a moderate or a growth type of asset allocation pool. They also have, many donor advised funds have options for sustainable investing and impact investing. So if you want to invest the assets inside of your donor advised fund in a sustainable investment fund, you're able to do that as well. Now, your contribution into the donor advised fund is tax deductible, and the assets inside of that donor advised fund grow tax-free. And again, we'll talk more about that in a second. But first, going back to how it works, you've opened the account, you've given it a name, you've donated assets into it, you've decided how those assets are going to be invested, you've taken the tax. deduction on the contributions that you've made. And then the final step is that when you're ready, you then can recommend a grant to any IRS qualified public charity that you care about.

So, for example, you can recommend that the money that's in there get granted to your local homeless shelter or a local food bank or an animal shelter or to a university. You can grant that money to your alma mater or to a religious institution. Any IRS qualified public charity is eligible for that grant. And you can choose whether to give that money anonymously or whether to receive acknowledgement. So if you want it to be known that the Rover the Dog Memorial Fund was the source of this $10,000 donation that you gave to your university, you can let that be known. But if you want to give it anonymously, you can also choose that instead. In other words, just because your fund has a name that's associated with it, the name that you gave it, doesn't mean that that name

has to be tied to the grants that you make. You always preserve the option to give anonymously. You also have the option of giving a grant in honor of someone or in memory of someone. And there are many public charities that will allow you to specify a particular use or campaign or purpose for the grant that you give. So for example, if you were to donate money to the American Red Cross, you could designate that you want this to be spent specifically on coronavirus-related projects. Or you could designate that you want it to be spent specifically on disaster relief projects. So there are many charities that will allow you to specify what purpose or what project within their organization you want that grant to support. When you go to open a donor advised fund, you'll notice the wording that Vanguard Schwab and Fidelity all use.

their wording is that you recommend grants. And they word it as you recommend the investments, meaning the way that that money is invested prior to when you recommend the grant. Now, the reason that they word it this way is because technically the money is no longer yours. Once you put money inside of a donor advised fund, you cannot take it out. It's like giving money to any charity. Once you make the donation, you can't get it back. Once money goes into the donor advised fund, it no longer. belongs to you. The technical term for this is an irrevocable contribution. And so the reason that

the wording that Vanguard Schwab and Fidelity I'll use is that you recommend these grants, you recommend that $10,000 go to the American Red Cross and specifically you want that designated for their coronavirus relief efforts. You're recommending that that is how the holder of the account grant that slice of money. Likewise, in how that money is invested, you're recommending that it get invested into a conservative asset allocation pool or a sustainable investing fund. The wording specifically will use the word recommend or recommended because of the fact that technically it's not your money, so you don't have technically the authority to decide what's done with it, even though for

all practical purposes, it's your decision. For all practice, for all practices, for all practical purposes, the recommendation that you make will be carried out. So two major benefits to donor advised funds. One is tax efficiency. So the contributions that you make into a donor advised fund are tax deductible. And if you donate long-term appreciated securities, securities that you've held for more than a year, you can give up to 20% more because your capital gains taxes are going to be minimized. So you can take a fair market value deduction, not a cash basis deduction. So for example, if you originally invested $5,000 and you put those in index funds, and over time that $5,000 turned into $8,000, well, when you donate that $8,000 in

index funds, assuming that you've held that for more than a year, when you donate that $8,000 into of index funds into a donor advised fund, you take a deduction for the full $8,000 fair market value of those index funds. You don't take a deduction for the $5,000 cost basis. What that means is that you've eliminated the capital gains tax on that $3,000 worth of gains. You are not passing that tax onto the charity. That tax burden simply disappears. You don't have to pay it. The charity doesn't have to pay it. So the benefit of donating long-term, appreciated securities into a donor-advised fund is that it has a huge tax advantage in terms of minimizing or eliminating those capital gains taxes. And you'll be eligible for an income tax

deduction on the full fair market value of the asset up to a maximum of 30% of your adjusted gross income. So the contributions that you make are tax deductible and you also avoid a long-term capital gains tax. The growth inside of the fund is tax exempt, just like a Roth IRA. And So in that regard, a donor devise fund is like mixing the benefits of a traditional IRA and a Roth IRA combined into one account. You have the money that goes in there as tax deductible benefit of the traditional IRA, and you have the money that is in there grows tax exempt benefit of the Roth IRA. In that regard, it's also similar to the benefits of an HSA, tax deductible growing in and tax exempt growth inside. So there are huge tax benefits.

with contributing money into a donor-advised fund. The other major benefit is convenience. So if you listened to episode 207 of this podcast, you can find it at Affordaintingthing.com slash episode 207. That was an episode in which I answered questions from you, the community, and with me to answer those questions was a certified financial planner by the name of Sophia Bera. She has been hailed by Investment News as one of the top 40 under 40 CFPs. And in that recording, we did that recording before I set up my donor advised fund, but she already had set hers up.

She describes in that recording the complexity of donating to a half a dozen different nonprofits and then having to track all of these separate donation receipts and coming to tax time and not being sure where she filed what documents. Like, oh, I think I kept the receipt from this one charity here, but I kept the receipt from this other charity over there. It was a big paperwork and administrative mess. And what she found when she opened her donor advised fund is that everything is simple and streamlined. She doesn't have to worry about tracking this giant pile of donation receipts. She can simply make these grants to different charities, different nonprofits, through the donor advised fund and everything is consolidated into just one fund, one place. She doesn't have to track every gift acknowledgement from every charity.

she can really reduce the paperwork in terms of reporting the charitable donations that she's made. And so the convenience of a donor advised fund, coupled with its tax efficiency, coupled with the fact that it is relatively easy to open, again, compared with establishing a foundation or a trust, that is what is making it so popular. So let's talk about the big three discount brokerages and the requirements that each of them have in terms of a, Count minimums and fees. We'll start with Vanguard. Vanguard has the highest hurdles of any of the big three. Vanguard requires a minimum donation to open an account of $25,000. And additional contributions that are made into the donor advised fund must be a minimum of $5,000. And then when you give grants to charity, the grants that you give to charity must be a minimum of $500. If you're thinking, whoa, holy moly, I did not imagine that a minimum amount open an account would be $25,000.

That was way more than I was expecting. If that is the thought that's going through your mind right now, don't worry, because both Schwab and Fidelity have much lower and more accessible minimum donations required to open an account with them. So Schwab requires a minimum donation to open an account of only $5,000. And additional contributions into the donor advised fund must be a minimum of $500. And if you grant money to charity, the minimum grant that you can give to charity is $50. That's through Schwab charitable.

And Fidelity Charitable is the same way. Fidelity requires a minimum donation to open the account of $5,000, same as Schwab. And the minimum grant to charity is $50, same as Schwab. So both Schwab and Fidelity will let you open an account for only a $1,000. $5,000 minimum initial donation, whereas Vanguard requires a $25,000 minimum initial donation, which means if you're choosing between the big three, unless you have over 25K to invest, either Schwab or Fidelity are going to be good choices for you. It struck me as I was looking at the amounts, comparing the amounts of the big three,

that the additional contributions, once your account is open, the minimum, additional contribution that Vanguard requires for any new money that you want to move into the account, Vanguard says that's got to be a minimum of 5K. Schwab says it simply needs to be a minimum of $500. So Schwab's minimum additional contribution is literally an order of magnitude lower. And that example perfectly highlights how much more accessible the two of them are from the other. All right, what about the fees associated with these accounts? Well, there are two types of fees One is the administrative fee, and this covers general operating costs like legal, accounting, processing, employees. That's the administrative fee that's associated with the account.

And at Vanguard, Schwab and Fidelity, all three of them charge exactly the same amount for the first $500,000 worth of assets that's in a donor-advised fund. And that amount is 0.6%. Vanguard, Schwab, and Fidelity all charge identical fees for the first $500,000. inside of a donor-advised fund. So they are neck and neck in terms of the administrative fee. Now, in addition to the administrative fee, there's also an investment fee which covers the costs of management of the invested assets. Essentially, that's like the expense ratio of the fund that you choose. And so added together, those are the all-in fees. So for example, if you are paying a 0.6% administrative fee and you're in a fund that has a 0.15% expense ratio or investment fee,

then all in the fee is 0.75%. Now, certainly that may sound high. If you're not used to paying admin fees, many of us, we're used to managing our taxable brokerage accounts and our IRAs and our 401ks. We're not used to paying administrative fees for those accounts. And so lopping a 0.6% fee onto money that's inside of an account sounds pretty high. But the reason that's there is to take care of all of the administrative costs that are associated with the existence of that account. All three of those brokerages have to hire people to process the paperwork and do the job of managing and maintaining those accounts. And all three of the major brokerages, which are all committed to rock bottom expenses. That's why they have the reputation of being discount

brokerages. They all charge exactly the same fee, admin fee. So that is a 101 primer on donor-advised funds. What are they? How do they work? What are the benefits? What are the fees? What's the minimum amount needed to open? Where can you open one? That is everything that you need to know about donor-advised funds. And so to close this out, I want to talk about a page. We'll link to it in the show notes. It's a page from Schwab Charitable, and it talks about five principles to boost your impact. Essentially, in zooming out and looking at the big picture, what can you do to make sure that the money that you are donating boosts your impact to the best of your ability? Step one, they advise defining your charitable mission. So take time to think about what you want

to achieve with your planned giving. Is there one or two particular causes that you want to focus on? or are there maybe five or six or ten or twelve different causes? Like, what is it? What's your mission? What do you want to achieve with the giving that you do? That's step one. Step two is identify your resources. And that means resources in terms of financial assets.

Again, we covered all of the different types of assets that can be donated into a donor-advised fund. Do you want to give restricted stock units to a donor-advised fund? Do you want to give interest that you hold in a privately held company into a donor-advised fund? Do you want to give cryptocurrency into it? So think broadly about all of your financial assets, not just your cash from a paycheck, but everything that you have. What resources do you have that you can give? And also, what time resources or skills or knowledge-based resources can you give to nonprofits in a volunteer capacity? So step two is identify the business.

those resources. And then step three is align your giving vehicles with your mission and your resources. So what role will a donor advised fund play in your overall giving strategies? Maybe the donor advised fund will be where you house all of your financial assets that you're going to give. And that is one slice of the pie. And then you have some other way of managing the time that you give as a volunteer, the time that you give donating pro bono services, professional. professionally or volunteering on the weekends. Maybe there's a different type of organization that you use for that. So think about how a donor-advised fund fits into the bigger landscape of all of the giving that you're going to be doing.

That's step three. Step four is then structure that. Create a plan that fits your financial situation, fits your time, that fits these assets that you've identified and fits the different types of giving vehicles that you've identified. Like, we figured out what your mission is. We figured out what your resources are. We figured out what vehicles you're going to use to house those resources. So now, like, structure all of that. How does that play in?

What kind of timeline are you talking about? Make a plan for how all of that is going to get executed. And then step five, measure and review. Make changes along the way. A year from now, look back on the giving that you did in 2020 and ask yourself, are you happy with what you did in 2020? Do you want to make any improvements to your giving strategy? So those are, according to Schwab Charitable, five principles to boost your impact and make the most out of the money, the time, the energy, the skills, the knowledge that you donate to worthy causes.

I also want to share a really beautiful comment that came from a previous PSA Thursday that we aired. So on May 29, we aired a PSA Thursday called Your Guide to Giving, How to Donate, Volunteer, and Practice Spontaneous Kindness. And in that episode, we talked about all of the different types of giving. It was sort of focused on that step two of what Schwab Charitable recommends, step two of the five principles, which is identifying your resources. In that episode, we talked very much about all of the different resources that are at your disposal and how you can create a plan. to be able to give those so that the way that you're handling your money, your time, your energy aligns with your values. So we aired that episode at the end of May, and we got this really beautiful comment from

Jay at Matt Ball Adventures, who says, hi, Paula and the Afford Anything crew. I left a brief comment on the Facebook page, but I can't help myself and wanted to comment here as well, left the comment on the show notes. I absolutely love that you took the time to focus on giving and believe this episode is very timely. At this point in the pandemic, the fiery podcasts and blog posts, at least those I've been able to keep up with, have tended to focus on personal financial survival. Now, this is extremely important, no doubt. But here's what I assume. Because of the great information disseminated here at Afford Anything and elsewhere in the fire community, fiery folks should,

in theory, be much better positioned to weather this storm and in a better position to give back. Not hearing much about giving surprised me. I found the lack of outward thinking a bit of a missed opportunity. This is exactly the time this specific community should be flexing its giving muscles. Scientifically, the jury is still out on whether money and or the pursuit of happiness will actually lead to life satisfaction. But there is an undeniable link between purpose, meaning, and generosity to happiness and life satisfaction. paradoxically, the pursuit of happiness doesn't often get you there, but happiness tends to follow meaning. Giving helps others, helps us, and should be part of the journey, even in, and I'd argue,

especially in, the hardest times. Wow. Like, wow. I could not have possibly said that any better. That is so, so beautifully said. And it articulates, exactly. exactly why I think that these conversations around giving are now more than ever, more important to have. Because the fire community is, as an aggregate, better positioned to be able to give than the majority of the rest of the American population.

and especially, especially at a time like now, you know, those of us who have already successfully put our oxygen mask on first, and those of us who are already in a financially stable, healthy place, we really have the opportunity to do a lot of good. And that's always true, but the year 2020 has really brought that into the forefront. So thank you. Jay at Matt Ball Adventures, thank you so much for that beautiful comment. And I'll close out this episode by encouraging you to give what you can. Whether that's your time, your money, your skills, your knowledge, make a plan, open a donor advised fund. And let's start using fire as a force for good. Thank you for tuning in. My name is Paula Pant. This is the Afford Anything podcast, and I will catch you in the next episode.