Using a Donor Advised Fund (DAF) to offset a Roth IRA Conversion

It’s been a while since I’ve wrote out finances, so let’s dig in, and let me preface this by saying that I am not a financial professional; please consult a professional (as I did) before you embark on any significant tax-saving strategies.

Okay, with that out of the way, let’s summarize two things: one, I think charitable giving is important, as I’ve written about before in several different essays. If you have the ability to help others and you’re currently not doing so, or if you wonder if you could be doing more, please consider reading my blogs on this topic, and in particular read about Peter Singer and his philosophy about giving money wisely.

Two, I’d like to have as much retirement income in tax-free accounts as possible - in other words, Roth accounts. I’m happy to pay taxes and contribute to the United States every year, but I also want to do intelligent and legal things to mitigate the tax I pay. Rich people do it, so I figure my family should take advantage of the same strategies when possible.

Now, you’re legally allowed to transfer money from a pre-tax retirement account like a traditional IRA or a 401k into a Roth IRA, but it’s a taxable event, and paying a big extra chunk in taxes is prohibitive most of the time. So even though I want to have as much of our retirement savings in a ROTH IRA so that we can withdraw money tax-free in our retirement, I’m not willing to do so if it means paying taxes now.

With that in mind, I’d like to discuss a method of satisfying both desires - giving to charity and moving money into a Roth IRA - without increasing your taxes.

In 2022 I learned about Donor Advised Funds (DAFs), a device that allows you to move more than one year’s worth of charitable giving into a fund for future distribution. The idea is that if you are able to contribute several year’s worth of charitable giving into a DAF in one calendar year, then you can then itemize the deduction on your taxes. This became especially important a few years ago in states like Illinois with high state and property taxes, because after the SALT tax deduction was enacted, these deductions were capped at $10K. So in 2022, when the standard deduction was $25, 900, it required an addition $15,900 of charitable giving before you could benefit from itemizing your deductions. In 2024 the standard deduction is up to $29,200, so it takes nearly $20K of charitable giving to begin to itemize your deductions.

Now, I’m aware that we should give to give, not to reap financial benefits. I get it. But we can give a whole lot more if we do get a deduction, which is why charitable deductions are allowed in the first place - to spur charitable giving.

For argument’s sake, let’s say you have $100K in a brokerage account somewhere and you like to donate $20K a year to charities (and I recognize that these numbers might be pie-in-the-sky - I’m just trying to make it simple). Depending on your income (there are restrictions, so do your homework) you could take $100K from your traditional IRA or 401K and transfer it to a Roth IRA, and then offset the tax implications for this event by moving $100K from your brokerage account into a Donor Advised Fund. The two events should be close to a wash, and you’ll wind up paying around the same tax as you did last year. And now you have five-year’s worth of charitable giving ready to go!

Even better, you can move appreciated assets into the DAF tax free, thereby avoiding capital gains on that amount. And wait, there’s more! The assets you have in the DAF can grow over time, allowing you to give even more money to your favorite charities!

Pretty slick, eh? To me, it’s a no-brainer, and I’m surprised that this strategy isn’t discussed more on-the financial pages I read.

I studied this method for weeks, wondering if I was missing something, and finally bit the bullet and emailed a financial advisor who I hire from time to time for a flat fee (always a flat fee - never a percentage) and asked him about the above strategy. He wrote: “Love this strategy, we do it all the time. Yes, I approve everything you are planning as described in your email.” He then went on to explain a few specifics to be aware of that were helpful, so please do your homework and get the advice of a professional before you pull the trigger.

If you’re lucky enough to have some assets on-hand that you don’t need immediately and you believe in helping others, consider looking into this strategy. It’s a win win win win.

Yes you can: Open an IRA for your Child

Money seems to be a preoccupation of mine these days, which is ridiculous, as there are more important things to consume one’s time, like albums, ping-pong and baseball.  But one aspect of money management I’ve embraced recently is one that every parent should at least consider: opening Roth IRAs for your children. 

Back in college, when my friend Mark announced that he’d just opened an IRA, not only did I not know what an IRA was, but once explained to me, I didn’t understand what the hurry was.  After all, I was still visiting the TYME machine (ATM to those of you from outside Wisconsin) three times a night to buy “just one more” pitcher of Hamm’s; the only foresight I possessed was drinking a glass of water to minimize the inevitable hangover the following morning.

Over time, I learned about saving early and saving often, and by now my family has reaped the benefits of this strategy, but I could no doubt be in a better position had I started saving prior to obtaining a full-time job after college graduation.  As a father of three, I’ve looked for ways to get my kids on the right track earlier than I did, particularly since debt accumulation is higher than ever and wages for many careers are stagnant.  Saving money might be more important for those currently in their teens and 20s than it ever was for those currently in their 40s and 50s.

Enter the custodial Roth IRA.  Yes, your kids can open an IRA (or, more accurately, you can open one for them if they’re under age 18).  Any money your kids earn up to $5500 this year can be put into an IRA.  That doesn’t mean your child can’t spend or save the money she’s earned this year; my two daughters earned small amounts in 2013, and they were allowed to spend or save that money as they saw fit, but I matched their amounts and put it into their respective IRA accounts.  Some companies don’t allow you to open up a custodial IRA – Fidelity is one example – and some brokerage firms require minimums that my 16 year-olds couldn’t reach, but there are several options to fit most people’s needs.  I ended up opening accounts through E*Trade, though I could just as easily have opened accounts at TRowe Price, Vanguard, Charles Schwab or TD Ameritrade. 

The idea of course is twofold: get your kids to become accustomed to saving (even if they’re currently not flipping the bill, they’re learning that saving for one’s retirement is important), and start growing their money.  My daughters only earned $900 and $1500, respectively, in 2013.  But if they manage to earn 7% for the next 50 years, that money will grow to $26,511 and $44,186.  Not a bad start.

If you can’t afford to match your children’s income in total, perhaps come up with a compromise and have your kids save a portion of their savings and you match that portion.  Even a couple of hundred dollars is better than nothing, and there are funds that will allow you to open an IRA for as little as $100.

One note: you can only invest legitimate earnings, so keep good records of your child’s income and file a tax return even if they don’t have any withholdings to recoup.  One of my daughters earned all of her income by babysitting and doing other odd jobs that didn’t require a W2 or generate a 1099, but I still had her fill out a tax return (form 1040EZ only took her 5 minutes to complete).  Throughout the year, I kept track of all of her earnings on an Excel spreadsheet and included it with my tax records.

There are great resources to get you up to speed on opening Roth IRAs for your children.  Three than I perused before taking the plunge are below:

http://www.forbes.com/sites/baldwin/2011/04/18/make-your-kid-rich-with-a-roth-ira/

http://www.investopedia.com/articles/personal-finance/110713/benefits-starting-ira-your-child.asp

http://www.kiplinger.com/article/saving/T046-C001-S001-give-the-gift-of-a-roth-ira.html

Now start keeping track of your children's savings, open up an IRA, select an index mutual fund, and watch it grow.