How Charitable Giving Can Improve Your Portfolio

Susan Dziubinski: Hi, I'm Susan Dziubinski from Morningstar.com. A strong market environment and year-end mean that it's an opportune time for investors to think about how they can be charitable, while also improving their portfolios, and today after all, is Giving Tuesday, the perfect time to discuss it. Joining me is Christine Benz, Morningstar's director of personal finance.

Christine, thank you for joining us today.

Christine Benz: Susan, it's my pleasure.

Dziubinski: Now, what's the connection between a strong market environment and charitable giving?

Benz: The big one is that many investors have appreciated securities in their portfolios. If they have stocks in their portfolios, chances are they've had some things that have gone up, and so the advantage of tying in portfolio repositioning with charitable giving, is that if you're going to make some changes and make charitable contributions, oftentimes it's more tax-advantageous to give securities directly to charity, rather than liquidating them, raising cash, and then sending cash to the charity.

Dziubinski: Now, we're going to talk about a few different strategies that tie into our investments, but one of the best and most tax-efficient is something that's available exclusively for those investors who are already taking their RMDs, and that's the qualified charitable distribution. Can you talk about that?

Benz: Right, so this is only going to apply, as you said, Susan, to people who are post age 70-and-a-half, so they're subject to those required minimum distributions that have to come out of their portfolios annually. And the way that you can use this qualified charitable distribution is that you can send up to $100,000 in RMDs to the charity or charities of your choice, and the virtue of using this qualified charitable distribution strategy, where you essentially let the financial provider work directly with the charities that you want to give to, is that by doing the QCD, the amount of that RMD that's going into the QCD is not affecting your adjusted gross income, so it's more advantageous to you to give this way.

The other big factor here is that many fewer investors, due to the tax law changes that went into effect in 2018, will be itemizing their deductions in the first place. So this, for a lot of investors, is the best way to make a tax save from their charitable giving. But again, you can only do it if you are subject to required minimum distributions. If you're a younger investor, unfortunately, this is not open to you.

Dziubinski: Now what can some of those younger investors do who don't have to take the RMDs yet? What are some strategies that they can use to tie their portfolios with charitable giving?

Benz: You'd want to look at finding appreciated securities in your taxable account, maybe where the position is just too lofty for whatever reason. So maybe it's company stock, and you don't want to be heavily invested in company stock because so much of your wherewithal is riding on your company's fortunes. So here might be a place where you could donate some of those appreciated securities to a charity of your choice. The trouble is--I mentioned the tax laws that went into effect in 2018--the trouble is, higher standard deductions mean that many fewer taxpayers are itemizing their deductions, and charitable contributions were a type of deduction that got itemized.

So one strategy that has come up in this context, is the idea of bunching charitable contributions and other deductible sorts of events together into a single year, where you can make them count, where you think, "Okay, in this year I think I'll be able to exceed the standard deduction, so I'm going to gang all these things up in a single year." That's where the strategy can be effective, and the other thing to keep in mind in the context of using your taxable holdings to gift to charity, is that by giving those securities to charity, you're effectively getting that tax gain out of your future tax bills, so you won't owe taxes on that appreciation, so that's another advantage.

Dziubinski: Then how does this tie in with portfolio management?

Benz: I think you want to take a step back and look at parts of your portfolio that you might want to reduce otherwise. So it might be that heavily concentrated individual stock position. It might be that you're getting close to retirement and saying, "Well, in my taxable account I have too much equity exposure," maybe too much U.S. equity exposure in particular. So you can maybe make that charitable contribution really count and improve your portfolio by reducing those positions, steering to charity, and doing so thoughtfully or strategically, so that you are exceeding that standard deduction threshold, at least in a few years out of a series of years.

Dziubinski: Right. And how might a donor-advised fund fit in here?

Benz: They might fit in in terms of being part of the strategy that you use with respect to your taxable holdings. So again, the idea is that you are steering money to the donor-advised fund, and in the year in which you make the contribution to the donor-advised fund, that counts as a charitable contribution, so you'd want to use some sort of a bunching strategy here as well. The donor-advised fund has a couple of advantages over making outright donations to charity. The first is that you can be deliberate in terms of making your contributions to charity, so in the year in which the money hits the donor-advised fund, well that counts toward something that you might deduct on your tax return, but then you can take your time getting that money steered into charity. You can even invest the money. So donor-advised funds may invest in long-term assets, stocks and bonds, and I think that can be another valuable strategy as well.

One other thing to keep in mind is donor-advised funds can accept individual securities, so they can take in-kind contributions of appreciated individual stocks, even some of the more-sophisticated donor-advised funds may be able to deal with illiquid securities, so that's another advantage as well. Your typical charity might not know what to do with those contributions, especially of illiquid securities. Donor-advised funds are usually set up, or often are set up to deal with those types of contributions.

Dziubinski: Oh, that's interesting. Christine, thank you so much. A lot of great food for thought during the holiday giving season.

Benz: Thank you, Susan.

Dziubinski: For Morningstar.com, I'm Susan Dziubinski. Happy holidays.