An episode from Vanguard’s Investment Commentary podcast series


Jason Method: Hello, and welcome to Vanguards Investment Commentary Podcast series. I’m Jason Method. In this month’s episode, which we’re taping on December 14, 2016, we’re going to discuss planned charitable giving. Garrett Harbron with Vanguard Investment Strategy Group is on the line from our Arizona office, and he’s here to explain how advisors can help their clients leave a legacy and maximize their giving through a tax-efficient strategy. Garrett is a coauthor of the new issue of Financial Planning Perspectives—Charitable giving: Three steps for a successful plan. Hello, Garrett, and thanks for joining us.

Garrett Harbron: Hi, Jason, great to be here.

Jason Method: Garrett, the subject of charitable giving comes up often late in the year as investors and advised clients consider their need for tax deductions. Why is charitable giving a good topic to start the year with?

Garrett Harbron: Well, effective giving is much more than just writing a check to your favorite charity. There’s absolutely nothing wrong with that, but it’s not the best way to get the most out of your charitable contribution.

To ensure that your charitable tax and estate planning goals are met, it really requires a plan, and planning takes time. And it begins with a holistic examination of a client’s goals and requires more than just a couple of weeks. Also, it often takes the services of a qualified financial planner to get the most out of it. So it really helps to start early in the year.

Jason Method: Your paper outlines three decision points on charitable giving: when to give, what to give, and how to give the gift. Let’s walk through those. What do investors and clients need to consider when determining when to give?

Garrett Harbron: Well, first, and most importantly, the investor needs to be charitably inclined. There’s no getting around the fact that gifts cost money, and although there can be estate and tax planning advantages associated with charitable giving, the odds of those benefits outweighing the cost of the actual gift are minuscule.

Then we need to look at some other factors that impact timing. The charity’s ability to manage a large gift; the desire to fund a specific project; the donor’s cash-flow needs, either real or psychological. These are all factors that need to be taken into account as part of a successful charitable-giving plan. And, again, that takes time and really takes working with a knowledgeable financial advisor as well.

Jason Method: Your section on what to give indicates that there are extra tax benefits that can be had when giving something other than cash. Help us understand that.

Garrett Harbron: Right. You know, cash is the most common thing that people give. You think about putting money in the Salvation Army bucket, writing a check to a charity; these are things that people do every day, but there are ways that you can support those charities that might also confer a greater benefit to you as the investor as well.

One example is by gifting appreciated securities. By giving a gift of appreciated securities, not only do you help the charity out, but you as the donor receive a tax deduction for the fair-market value of the security gifted, and you get to avoid capital gains taxes on those appreciated securities as well. So there’s really almost a double tax benefit there.

Appreciated securities is not the only type of property that you can give. Gifts of real estate, art, collectibles, automobiles, any kind of property can be given to a charity. They do tend to be a little bit more complex than gifts of cash, but they also carry a potentially higher benefit.

Jason Method: Yes, donations of appreciated securities or particularly real estate seem pretty complicated.

Garrett Harbron: They can seem more complicated, but appreciated securities, for example, aren’t as complicated as they seem. Charities are used to accepting these gifts, they’re fairly common, and procedures for effecting a gift of appreciated securities is relatively straightforward.

When you start getting into things like real estate, especially, those can be pretty complex, and not all charities will accept gifts of real estate. So it’s important to check with the charity ahead of time, make sure they’re willing to accept that gift, and remember that it does take time to make that transfer when you’re talking about appreciated property.

Jason Method: Are there any limits to the tax deductions that are available?

Garrett Harbron: Yes, for any type of gift, there are limits to the tax deductibility. Typically for a cash gift, you can deduct charitable donations up to 50 percent of your adjusted gross income.

When you’re donating appreciated property, that threshold is lower. It’s only 30 percent of adjusted gross income, but you do get to avoid those capital gains as well.

Jason Method: If you exceed those limits, do you lose those deductions forever?

Garrett Harbron: No, you can carry forward unused charitable donations for up to five years.

Jason Method: Garrett, is it more advantageous to give from certain types of accounts?

Garrett Harbron: Generally speaking, it’s more advantageous to give from a traditional IRA. Because IRAs are funded with pre-tax dollars and the donation itself is tax-deductible, when you gift from a traditional IRA, that makes the complete donation tax-free.

Jason Method: And what about taxable accounts and thinking about heirs as well?

Garrett Harbron: If you’re thinking about heirs, you’re really better off leaving either a taxable account or a Roth IRA to your heirs. The reason for that is that the heirs get the step-up in basis in a taxable account, which really reduces the amount of taxes they have to pay on it. And with a Roth IRA, all the distributions to the heirs are tax-free anyway. If you compare that to a traditional IRA, where the heir has to pay income tax on the distributions from the traditional IRA, it’s not hard to see why traditional IRAs are often best left to charities.

Jason Method: Okay, so we’ve talked about when and what to give. That leaves how to give. How much difference can the giving method make to an investor’s charitable giving or wealth plan?

Garrett Harbron: It can make a huge difference. One great example is the difference between a deductible gift and a qualified charitable distribution, or QCD. We see QCDs a lot with investors who are taking required minimum distributions from their traditional IRAs. What happens with a QCD is, you designate the money to go directly to the charity, and it counts toward your required minimum distribution but does not count toward your income. And that’s really important because there are a lot of things that are contingent upon your adjusted gross income [AGI].

For example, Medicare Part B premiums, the deductibility limits for itemized deductions, the charitable-deduction limitation, these are all things that revolve around AGI. And by making a qualified charitable distribution, that never becomes part of your AGI.

Jason Method: Garrett, that sounds like important information for retired investors and those taking Social Security.

Now, in your paper, you mention some strategies for clients or investors who want to benefit their heirs and charity at the same time or who haven’t decided yet what charity they want to give to. Can you discuss those?

Garrett Harbron: Sure. There are really three that we discuss in the paper. The first is the charitable lead trust. We also discussed the charitable remainder trust and the charitable annuity along with that, and then, finally, the donor-advised fund. And these are great for serving multiple goals at the same time.

With the charitable lead trust, for instance, the charity gets an income stream during the life of the trust. And then whatever assets remain in the trust at the end of the trust period go to the donor’s heirs.

This has some real advantages for the donor in that it takes these assets out of the estate and their future growth as well, supports a charity for a period of time, and then passes those remaining assets on to the donor’s heirs estate tax-free.

Opposite of that, in a lot of ways, is the charitable remainder trust. With the charitable remainder trust, a noncharitable beneficiary, typically the donor, receives an income for a period of time or for life, and then any assets remaining in the trust at the end of that period go to a charity.

The assets that are deposited into the trust are immediately removed from the donor’s estate, along with their future growth. The donor receives an income stream from those assets for life, and then the charity benefits at the end of the trust period. So, again, a great way to benefit the donor and the charity at the same time.

A charitable annuity is almost identical to a charitable remainder trust, except instead of putting the money into a trust, the money is paid directly to a charity, and then the charity actually pays that income stream to the donor.

The last vehicle then that we mentioned is the donor-advised fund, and this is a little bit different in that it doesn’t provide the income to one party and then the remainder to another. But it’s a way to accelerate giving. With a donor-advised fund, you deposit money into the fund, you get an immediate tax deduction for the full amount of the donation, and then you can give from that fund over time. So that’s a great way for people to fund a long-term giving strategy over a relatively short period of time.

Jason Method: Can you also provide securities to a donor-advised fund?

Garrett Harbron: Absolutely. Not only to a donor-advised fund, but to either of the trusts that we mentioned as well. And like any other donation of appreciated securities, when you do that, you get to avoid the capital gains on those appreciated securities.

Jason Method: How does someone think through the different considerations to decide which one of these they may want to use?

Garrett Harbron: You know, that’s a really complex topic. We advise that investors consult with a financial planner when they’re making these decisions. The rules that govern any of these strategies that we’ve talked about today are very complex, and while they can be very valuable to investors if done properly, if done improperly, they can end up being very costly. So we really advise engaging a qualified financial planner when looking into these strategies.

Jason Method: What else is there for us to keep in mind about these?

Garrett Harbron: It’s important to remember also that a lot of these strategies are irrevocable, meaning that once the strategy is implemented and the assets are deposited into the trust or the donor-advised fund, there’s no going back. The donor can’t later go and try to reclaim those assets or change the beneficiaries or the charity payouts or any of those things. So it’s important, again, for clients to consult with their financial planner before engaging in one of these strategies to make sure that they aren’t unintentionally negatively impacting some other area of their financial plan.

Jason Method: Wow, Garrett, that is a lot for us to keep in mind. Thanks for being with us today. We appreciate your time and your insights.

Garrett Harbron: Thanks, Jason, it’s been great talking to you.

Jason Method: And thank you for joining us for this Vanguard Investment Commentary Podcast. To learn more about charitable giving, check out our website and look for the new issue of Financial Planning Perspectives—Charitable giving: Three steps for a successful plan. Also, feel free to visit, Vanguard’s nonprofit donor-advised fund and philanthropy, which has provided more than $6.1 billion in grants since its inception.

Be sure to check back with us each month for more insights into the markets and investing. Remember, you can always follow us on Twitter and LinkedIn. Thanks for listening.


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