Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Donor-Advised Fund
Transcript
- Lucas: So I was talking to a couple last week, both retired at fifty-two, and they said something that stuck with me. They'd spent twenty years accumulating, and now they wanted to give back, but every time they tried to write a check to a charity, they felt like they were doing it wrong. Luna: Doing it wrong how? I mean, a donation is a donation, right? Lucas: You'd think so. But they had a pile of appreciated stock sitting in a taxable account, and every time they sold some to donate, they triggered capital gains tax. So they were actually paying taxes to give money away. That's backwards. Luna: Okay, that does sound backwards. So what's the fix? Lucas: The fix is a donor-advised fund. It's a charitable account that lets you contribute appreciated assets, take an immediate tax deduction, and then recommend grants to charities over time. You avoid the capital gains tax entirely, and the full market value of the stock counts as your charitable contribution. Luna: Before we go deeper, I know a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and honestly, that's what keeps this show ad-free and lets us do deep dives like this every day. So if that's ever felt like a small gesture, it's not — it's literally the engine. Lucas: Yeah, and we don't take that for granted. It's a small group, but it's a real one, and it means we can keep doing episodes on exactly the questions you're asking. Luna: Exactly. Now, back to donor-advised funds. How does the mechanics actually work in practice? Lucas: Let's use that couple. They had about two hundred thousand dollars in a single stock they'd held for over a decade, bought at fifty thousand. If they sold it, they'd owe capital gains on a hundred fifty thousand. At fifteen percent, that's twenty-two five in taxes. Luna: Ouch. Lucas: Instead, they contributed the stock directly to a donor-advised fund. No sale, no tax, and they got a deduction for the full two hundred thousand. That deduction can offset up to thirty percent of their adjusted gross income in the year of the contribution, and they can carry the rest forward for five years. Luna: So it's like a tax shelter, but for giving. Lucas: Exactly. And since they're retired, their income is relatively low, so they can bunch contributions — make a large donation every few years to exceed the standard deduction, then take the itemized deduction in those years. That's a classic strategy. Luna: But what about the actual giving? I mean, you put money in, you get a tax break, but then what? Lucas: Right, that's the 'advised' part. You recommend grants to any irs qualified public charity. The fund does the diligence, writes the check, and you get to decide where the money goes, when. You can do it all at once or stretch it out over years. Luna: So it's like a charitable checking account. Lucas: That's exactly how I describe it. You contribute — ideally in a high-income year or when you have appreciated assets — and then you can take your time deciding which causes to support. That's especially useful for early retirees, because you might not know yet what you're passionate about. Luna: And you can also put cash in, right? It doesn't have to be stock. Lucas: No, cash works too, and the deduction limits are different — sixty percent of AGI for cash versus thirty for appreciated assets. But the stock move is the one that saves you the most, because you're dodging the capital gains tax. Luna: So what are the downsides? There's got to be some. Lucas: There are a few. First, once you contribute, the money is irrevocably charitable — you can't change your mind and take it back. Second, there are fees. Most funds charge a small annual fee, usually around one percent of assets, and some have minimums, like five or ten thousand dollars to open. Luna: But that's still less than a private foundation, right? Lucas: Way less. A private foundation has setup costs, annual excise taxes, and a five percent minimum distribution requirement. For most people, a donor-advised fund is simpler and more cost-effective. The only reason to go the foundation route is if you want to employ family or have a very large sum, like tens of millions. Luna: Okay, so say I'm an early retiree listening to this. How do I actually set one up? Lucas: It's surprisingly easy. You can open one at a major financial institution like Fidelity, Schwab, or Vanguard. You fill out a form, fund it with cash or stock, and you're done. The whole process can take less than a day. Then you just log in and recommend grants whenever you want. Luna: And you mentioned using it with Roth conversions. Can you walk us through that? Lucas: Sure. Say you're doing a Roth conversion ladder, which we covered in episode 162. You convert, say, fifty thousand from a traditional IRA to a Roth, and that adds to your taxable income. If you also make a large charitable contribution in that same year, you can offset some of that income with the deduction. It's a two-for-one: you reduce taxes and build your Roth balance tax-free. Luna: But does that work if you're not itemizing? Lucas: That's the trick. You need to bunch. If your standard deduction is, say, twenty-seven thousand for a couple in 2026, you can make a big DAF contribution every other year to push your itemized deductions above that threshold. Then you claim the charitable deduction that year, and take the standard deduction in the off years. Luna: So it's not every year, but it's a rhythm. Lucas: Exactly. And the beauty is, you control the timing. You can contribute in a year when your income is unusually high — the year you sell a business, or take a large capital gain — and then grant out the money over the next several years, even if your income drops back down. Luna: That sounds really clever. But what about the emotional side? I mean, giving money away can be surprisingly hard for people who've spent decades accumulating. Lucas: It is, and that's something I see with a lot of early retirees. They're used to watching the number go up, and suddenly they're supposed to be okay with it going down. But a donor-advised fund actually helps with that, because you get the tax benefit upfront, and the actual giving can be a slow, deliberate process. You don't have to decide everything on day one. Luna: And you can involve your family, right? Like, get the kids involved in deciding where to give. Lucas: Absolutely. Many funds allow you to name successor advisors, so your children can continue recommending grants after you're gone. It's a way to pass on your values, not just your wealth. And for early retirees, who might have decades ahead of them, it can become a meaningful family activity. Luna: I love that. So, bottom line: who should consider a donor-advised fund? Lucas: If you're an early retiree with appreciated assets, a desire to give, and a tax strategy that involves Roth conversions or bunched deductions, a donor-advised fund is probably worth a look. It's not for everyone — if you give a small amount each year, the fees might outweigh the benefits. But for anyone with, say, twenty-five thousand or more to give, it's a solid tool. Luna: And it's really about being intentional with your money, even when you're giving it away. Lucas: Exactly. That's the thing — financial freedom isn't just about accumulating. It's about deciding what you want your money to do. And for many early retirees, that includes making an impact. A donor-advised fund is one of the most efficient ways to do that. Luna: Well, that gives us a lot to think about. Thanks, Lucas. Lucas: My pleasure. And if you're curious, most of the major providers have calculators on their sites that show you the tax savings of donating appreciated stock versus selling. It's an eye-opener.