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3 Charitable-Giving Strategies That Can Also Improve Your Portfolio

Late in the bull market, appreciated assets can be ripe for the picking by the charitably inclined.

Investors who would like to make charitable contributions in 2020 might find themselves with a conundrum: Even though the pandemic has exacerbated many needs--food, healthcare, and shelter, for starters--some prospective givers might find their incomes temporarily depressed this year. Many workers have lost jobs or experienced income reductions. And retirees aren’t required to take distributions from their tax-deferred accounts, thanks to the CARES Act. That reduces the amount of ready cash that some individuals have available for giving, and the fact that incomes are reduced also reduces the tax break on charitable gifts. If you’re typically in the 32% tax bracket but you’re in the 22% bracket this year, it may be better taxwise to make charitable contributions after your taxes have gone back up.

But there’s a countervailing force. If you’re charitably inclined and an investor, it’s been a pretty good year thus far, one in a long-running stretch of more than a decade. Thus, it’s a good bet that you have some appreciated assets in your portfolio. Trimming them can yield charitable gifts, earn you a tax break, and improve your portfolio. As 2020 winds down, U.S. growth stocks and funds--especially those related to the technology sector--appear especially ripe for the picking.

Here are some ways to tie in charitable giving with improving and rebalancing your portfolio.

Qualified Charitable Distribution If you're over age 72, you know the drill: In most years, you're required to take a distribution from your tax-deferred accounts. Thanks to the CARES Act, required minimum distributions are on hold for 2020, but qualified charitable distributions are still allowed. Under the QCD maneuver, investors older than age 70.5 can steer a portion of their IRA distributions--up to $100,000--directly to the qualified charities of their choice.

The tax break: In normal years the QCD satisfies the RMD requirement, but what about in 2020, the year of no RMDs? A QCD may still make sense for a few reasons. One is that it enables you to give pretax assets to charity, and the other is that it reduces the size of your IRA that will eventually be subject to RMDs in the future. It's also important to note that you don't need to itemize your deductions to be able to take advantage of the QCD. Even if you're doing just a modest amount of giving in 2020, it still may make sense to do it via the QCD if you're eligible.

The portfolio benefit: A QCD can tie in with portfolio maintenance and improvement if you strategically prune those holdings in your portfolio that have grown too large and/or are overvalued. Once you've liquidated or reduced the positions, you can then direct the proceeds to charity via the qualified charitable distribution.

Donating Appreciated Securities Qualified charitable distributions are appropriate for older investors who have much of their wealth in their tax-deferred accounts. But what if you're not subject to RMDs, or you hold most of your assets in taxable accounts? In that situation, donating appreciated securities from your taxable account to charity can make sense.

The tax break: If you donate appreciated securities, you won't owe capital gains taxes on the appreciation in the shares, and you can deduct the full market value of the shares at the time of the donation, provided you've owned them for up to one year and provided the deduction is less than 30% of your adjusted gross income. (For 2020, a higher threshold of 100% of adjusted gross income applies to donations of cash, but the 30% threshold applies to gifts of appreciated long-term assets.) If the amount of your donation exceeds what's deductible this year, any excess can be carried forward and deducted for up to five years in the future.

As noted above, you’ll want to factor in whether you’re itemizing your deductions or any changes in your tax bracket. If you’re in a lower tax bracket this year but expect it will go back up next year, or if you won’t be itemizing your deductions in 2020 but may do so in 2021, you might get more bang for your buck by waiting to make the donation.

The portfolio benefit: Donating appreciated assets from a taxable account tends to be the best fit for investors who have highly concentrated positions in individual holdings with a low cost basis. For example, perhaps you've run an X-ray on your portfolio and determined you have way too much riding on the tech sector, thanks largely to a tech fund that overlaps heavily with broad-market exposure in your portfolio. You could donate all or a chunk of that tech fund to charity, thereby reducing risk in your portfolio while also enjoying a tax benefit.

Donating Appreciated Securities via a Donor-Advised Fund Employing a donor-advised fund is what Sheryl Rowling, Morningstar's head of rebalancing solutions, has called a "super-charged" charitable-giving strategy. You contribute cash or investment assets to the fund, which is a charity in the eyes of the IRS. You can then direct contributions from the donor-advised fund to various charities over time, and can also contribute additional monies to the donor-advised fund. As the donor, you're also in charge of how the money is invested; most donor-advised funds feature a short menu of investment options ranging from very conservative (for monies that will be disbursed soon) to more aggressive (for assets that will be distributed to charity further in the future).

The tax break: From a tax standpoint, the key benefit of using a donor-advised fund is that is that you gain an immediate tax deduction on the amount contributed. If you contribute cash, you can take a deduction of up to 60% of adjusted gross income; if you contribute long-term securities, the deduction is limited to 30% of adjusted gross income. The contributions are irrevocable, which is why you can obtain the tax benefit right out of the box, even though the amount isn't necessarily being disbursed straightaway.

If you find yourself in a particularly high-tax year, you may benefit from employing a donor-advised fund; it enables you to obtain the tax deduction in that year but move deliberately to donate that money to charity over a period of months or years. But as with donating appreciated securities, the flip side is also true. if you’re not itemizing or your income is at a low ebb in 2020 relative to what you expect it to be in the future, this maneuver isn’t for you this year.

The portfolio benefit: As with donating appreciated securities directly to a charity, you can steer highly appreciated assets into the donor-advised fund, thereby removing the tax burden associated with the embedded capital gain from your portfolio. (The charity does the selling, not you.) Donor-advised funds may be particularly appropriate for investors with non-publicly traded assets, like stock of private companies. Many charities can handle donations of publicly traded securities, as in the maneuver outlined above; the charity can simply liquidate the position in the open market and direct the proceeds back into the charity. But most charities are not equipped to deal with nonpublic assets; donor-advised fund administrators have more experience with assets such as restricted stock and ownership stakes in nonpublic companies.

Donating nonpublic assets to a donor-advised fund can also simplify the administration of a donor's estate, in that heirs won't be required to find a buyer for those assets, while removing those highly idiosyncratic, often high-risk, assets from the investor's portfolio.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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