By Jeffery J. McKenna, Esq.
Barney McKenna & Olmstead PC
I have a neighbor who loves tools. He can fix anything. In his garage he has hundreds of tools. My toolbox at home is nothing like my neighbor’s collection. I have a hammer, two screwdrivers, a pair of pliers, and, of course, duct tape. I’m sure my neighbor has a “best” tool.
For over 20 years as an estate planning attorney, I have used “tools” to help save taxes and facilitate the administration of my clients’ estates.
I have a few “best” tools that I really like to use. In order to avoid thousands—even up to hundreds of thousands—of dollars in taxes for clients, I reach for the donor advised fund (DAF) in my charitable giving “toolbox.”
Donor advised funds are sub-funds of a larger charitable entity. They are an individual’s or a family’s own private charity. Monies or investments go into the fund with a tax deduction and grow tax free. The monies come out tax free, but they must be directed to churches, schools, or other charitable 501(c)(3) organizations. There is no time requirement with respect to how soon the monies must be distributed.
A donor advised fund is a wonderful estate planning tool for many reasons.
First, it is refreshingly simple. Many estate planning tools are difficult and complex. A DAF can usually be set up using a standard form of two or three pages. The fund is nothing more than an account at a sponsoring organization, usually a public charity. The account has an advisor who directs the distributions; usually the advisor is the creator of the fund. Upon one’s death or when establishing a testamentary donor advised fund, a secondary advisor can be named.
Second, donor advised funds can be someone’s own private “charitable checkbook.” Monies left in a fund for family members can be used throughout decades of charitable giving for children and grandchildren. This becomes particularly appealing when individuals or families are tithe payers or desire to fund family members’ missionary service—and when the assets funding the donor advised fund are qualified retirement accounts. IRAs or 401(k)s that are normally subject to income tax and possible estate tax become non-taxable for both taxes when a DAF is named as the testamentary beneficiary. A client with a large retirement account and four children can create four testamentary DAF accounts. Each of the four children can be the advisor for their family’s separate inherited donor advised fund. Upon the client’s death, the retirement accounts would then be distributed tax free to the DAF accounts. Clients can discuss this tool with their family and determine the ideal percentage of the taxable retirement account to fund the donor advised funds.
Third, if IRA or 401(k) monies are left to a donor advised fund upon a donor’s death, significant amounts of taxes are avoided. Every dollar that would have been taxed can flow into the donor advised fund tax free and can continue to grow tax free—Uncle Sam doesn’t get a dime. As you likely know, tax law changes that would reduce the estate tax exemption from $11,700,000 per person to $3,500,000 per person ($7,000,000 for a married couple) and would increase the estate tax rate from 40 percent to 61 percent are being proposed by the Biden administration and may take effect in 2021. Many individuals who were not previously at risk of paying estate tax now require additional planning to avoid the ramifications of the pending changes.
Lastly, donor advised funds can be used to “bunch” charitable contributions. Individuals who have a history of charitable giving may want to consider a practice called bunching to take advantage of current tax laws. The current standard deduction that can be subtracted from taxable income without itemizing is $12,550 for individuals and $25,100 for married couples (note that the standard deduction is an additional $1,300 per person over age 65). Bunching contributions allows donors to contribute to their donor advised fund to take best advantage of the tax laws. A donor can contribute an amount equal to the total needed for three years to their donor advised fund. In that same year, the donor itemizes their deductions when filing their tax return. In the following two years, the donor makes contributions from the donor advised fund and claims the standard deduction on the tax returns for those years. This method allows the donor to maximize the tax benefit of their charitable contributions.
Just as my neighbor has his “best” tool for the job, I like using donor advised funds. They are refreshingly simple, can eliminate tens of thousands of dollars in taxes, and are a great tool for intergenerational charitable giving, especially when used with IRAs and 401(k)s.
You may want to consider placing the DAF in an easy-to-reach place within your estate planning toolbox.
Jeffery J. McKenna is an estate planning attorney serving clients in Utah, Nevada, and Arizona. He is a shareholder at the law firm of Barney McKenna & Olmstead, with offices in St. George, Utah, and Mesquite, Nevada. McKenna is a founding member and former president of the Southern Utah Estate Planning Council.
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