Charitable Giving: Role in a Financial Plan

As you build your portfolio and consider ways to allocate assets, it’s natural to desire to put your money to the best use possible. While, in many cases, this involves buying higher-yield investments and contributing to retirement accounts, another use of your funds can be more selfless — donating to charities or causes you deeply believe in.

In this article, we’ll explore the function of charitable giving in a financial plan, the tax implications and different methods of philanthropic donations, and how a financial professional can help you put your plans into action.

Understanding Charitable Donations

Charitable giving involves donating money or assets to another individual, organization, or cause. You may choose to do so for myriad reasons, but it’s common to consider giving to charity when you have a cause you care about and want to support directly. For many people, it can feel good to know they’ve done their part to help with something greater than themselves, and they may even wish to inspire others to do the same through their actions.

Here are some examples of common causes or movements people may support:

• Animal rights
• Civil rights
• Drug prevention
• Education
• Environmental and climate issues
• Global aid
• Physical and mental health care
• Politics
• Religion

Giving can have a unique place in a comprehensive financial plan, often due to its potential tax advantages but also because it can be a way to curate and track your support toward philanthropic causes. It’s not uncommon, as well, to begin weighing it as an option after you have built your wealth up to the point where you feel comfortable donating some of it without anything specific in return.

“Charitable planning at its core needs to start with the desire for a client to shift assets to an organization to help fulfill [its] mission and purpose, understanding that they are giving up these assets to use for themselves,” explains Marissa Beyer, CFP^®, Senior Wealth Advisor and Partner at Fidato Wealth.

When considering integrating philanthropy into your financial picture, it’s helpful to consult a financial advisor. As we’ll explain further, along with a range of other tasks, a professional could assess your plans, work with you to figure out how much of your income you could afford to donate, and help you understand the tax implications of different types of charitable contributions.

Methods of Charitable Giving and Tax Implications

You can fit various modes of charitable giving into your financial plan. Depending on the method you choose, you may be able to receive certain tax advantages. For instance, with some forms, you could deduct contributions on your annual tax documents, reduce capital gains tax, and, in other cases, could draw funds from retirement vehicles.

Below is a breakdown of the different contribution methods and their tax implications:

Cash Donations

Perhaps the simplest way to give money to a charitable cause is with cash. There are many ways to do this, often depending on how the organization accepts payments and what you’re comfortable with. For example, you could make a credit or debit card transaction, write a check, or even hand in an envelope with cash.

Cash contributions are one of the most flexible ways to give money to a cause because they often don’t require you to jump through hoops. Crowdfunding websites like GoFundMe and fundraising events, such as silent auctions, galas, or golf tournaments, make it easy for almost anyone to be a benefactor of philanthropic causes with cash donations.

While cash donations are straightforward, they come with some drawbacks for tax optimization. As Beyer points out, cash is “[t]he most taxed and inefficient way” to contribute to charitable causes because even though “clients receive an itemized deduction on their tax return, assuming they are itemizing, the gift of cash does not allow a client to leverage any other assets that they have for tax planning beyond the deduction that year.”

Appreciated Assets

Another way to support a cause or organization is with appreciated assets, such as stocks, bonds, real estate, and private equity investments. These have a unique tax advantage in that they let you bestow potentially substantial investments to charities while also not paying capital gains tax in certain cases.

Ordinarily, with assets such as stocks or real estate that grow in value, you must pay capital gains tax when you sell them and realize your gains. However, you can deduct the fair market value (FMV) and avoid paying taxes on the capital gains you would have otherwise faced if you donate them to a qualified charitable organization.

Beyer notes, “For a one-time gift, an advisor may suggest gifting appreciated stock directly to the charity. This allows the client to avoid having to pay tax on that large gain at some point in the future. The built-in gains within the investment will not be incurred from the charitable organization.”

Qualified Charitable Distribution (QCD)

A subsequent tax-advantaged method of contributing to charitable causes is using qualified charitable distributions (QCDs). Available when you’re at least 70.5 years old, a QCD is when you draw funds out of a traditional Individual Retirement Account (IRA) to pay directly to a qualified charity tax-free.

When withdrawing funds from a traditional IRA, you normally must pay income tax. Therefore, a key tax benefit of a QCD is that your donations avoid taxation, allowing you to maximize the amount you give to charity. If you have a 401(k) through your employer, you could also roll the funds into a Roth or traditional IRA and employ QCD donations.

Beyer highlights that using a qualified distribution “can be a very effective tool” for individuals without “a lot of non-qualified assets” — referring to investments lacking tax benefits — and for people “whose assets are in an IRA.” From the perspective of a professional helping clients, she says, “As an advisor, if you have done proper cash flow planning and understand a client’s goals, as well as the income sources and other resources they have for retirement, distributions via an IRA directly to a charity can help avoid an additional income tax liability for the client.”

Donor-Advised Fund (DAF)

A donor-advised fund (DAF) is another effective method to support philanthropic causes and organizations. This is a fund that a charitable 501(c)(3) organization opens and manages that lets individuals open accounts to give irrevocable donations of cash and investments while receiving a tax deduction. As the name suggests, however, the donor gets to maintain a say in how the contribution gets used and where it ends up.

Leveraging a DAF, Beyer says, can be a good strategy if you desire “more perpetual consistent giving” but also would like to extend “gifts to various organizations.” Specifically, she says, a DAF grants the “flexibility of gifts to various charities, while allowing [you] to select the amount and duration of when gifts will be paid out, as well as the ultimate flexibility of allowing for the entire gift into the DAF to receive a tax deduction in the same year.”

In the context of a broader financial plan that includes a portion of charitable giving, a DAF as a philanthropic vehicle can also have some considerable benefits when planning your taxes, adds Beyer. She highlights that this is especially true “in a year where a client has more income than normal, such as a large bonus, exercising of non-qualified stock options, or proactive planning through Roth conversions.”

Through an Estate Plan

Finally, you may also consider giving strategies that take effect once you pass away. In these cases, you would include philanthropy as an element of an overarching estate plan, whether you intend to leave all your assets to charity or just a defined portion.

The role of charitable donations in an estate plan may take many forms, but an option is placing the funds in a trust and setting one or more charities as beneficiaries. You may also wish to pass on the assets in your retirement accounts, such as 401(k)s, 457(b)s, or Roth IRAs, to organizations.

Role of Financial Advisors in Philanthropic Planning

Incorporating charitable giving into a financial plan can be complex and challenging, especially if one of your goals is maximizing tax benefits. Therefore, it’s smart to meet with a financial advisor who can help you understand how your philanthropic plans may take shape and provide insight into tax implications.

An advisor may ask whether you desire to contribute to charitable causes. A misconception, however, is that you must be exceptionally wealthy to do so. While you can, of course, make a significant difference if you have more to give, it’s still possible to make meaningful philanthropic donations with an average income. Ultimately, though, it will be up to you to decide if it’s something you feel comfortable fitting into your plans — which is what your advisor will help assess.

“Charitable planning is very personal and most importantly needs to start with a charitable desire from a client, as well as the confirmed financial ability to give assets without creating future financial insecurities,” Beyer says.

Your financial professional will also be able to provide clarity and direction on effective methods of charitable giving, such as using cash and appreciable assets, as well as methods such as QCDs and DAFs. They’ll be able to explain the multiple advantages and drawbacks to keep in mind, especially involving tax deductions, as well as how they could influence your financial plan.

Beyer explains the role advisors like herself have in planning charitable giving:

As advisors and particularly fiduciaries, it is our job to understand a client’s full financial picture, assess gaps and opportunities, while weaving in their values and goals – all while accounting for their various asset composition and an overlaying tax strategy. Charitable planning can be both very financially advantageous and emotionally satisfying when properly planned for.

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