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Retired Military Finances 301: Donor Advised Funds

Taxes

I can't say that it was the same for you as me, but while I was on active duty most of my contributions were made either through the Combined Federal Campaign or a check I wrote to the charity. I'm pretty sure that is the least tax efficient way to support charities. Now that you're retired you might want to consider using a Donor Advised Fund (DAF).

What is a Donor Advised Fund?

A DAF is a 503(b) charity in and of itself. They're normally administered by a brokerage or a mutual fund company. A DAF holds assets donated by you until you advise them to give them to a designated charity. As long as the charity is a qualified charity your funds will likely be transferred to the designated charity by the DAF. It is important to note, that you aren't required to distribute all the funds contributed in the year you contribute them. You must make distributions though and 5% a year or more is a good rule of thumb.

So, in summary you can contribute funds to a DAF now, take a tax deduction for the full amount contributed and then pay it out over time to a charity you support.

Benefits of a DAF to Retired Military Officers

A DAF offers several benefits.

  • If you're still working in your post-military career, there is a pretty good chance you're in a higher tax bracket now than you will be in retirement. Making the contribution now to a DAF could result in a bigger reduction in your total tax bill than if you make a contribution each year into and including your ultimate retirement
  • You can avoid capital gains taxes. If you're sitting on some investment that you bought when you were a captain because you don't want to pay taxes on the capital gains you've made, you can contribute the investment "in kind" to the DAF. You'll take a deduction based on the Fair Market Value on the day of contribution (assuming you have held the security for more than one year). You'll transfer the tax bill into the DAF and since it is a charity, it won't pay taxes on the gain when the investment is sold.
  • Under the new tax law, fewer taxpayers will itemize deductions. Those who don't itemize and make charitable contributions lose the tax benefits associated with the charitable contributions. If this applies to you, making a contribution to a DAF that represents your next "X" number of years of contributions to your favorite charity could allow you to deduct a portion of the contribution in the year you donate to the DAF rather than being forced to take the standard deduction each year.

Warnings, Notes and Cautions

There are a few things to watch for though.

  • Contributions to a DAF are irreversible
  • There could be an additional level of fees associated with a DAF
  • Make sure you can still accomplish the financial goals you've established if you donate the securities now and replenish them over the upcoming years
  • Technically, as mentioned above you only advise on where you want the funds to go. While I've never heard of this happening, it is at least conceivable that the administrator of the DAF could not follow your advice

Understanding the Tax Code is an All Day Task

Somebody, either you or your advisor, needs to spend a lot of time studying the tax code to make sure you minimize your tax bill. And in the case of active duty or retired military officers, that person needs to understand your military and veterans benefits as well. If you go down the path of working with a financial advisor or planner, make sure he or she understands your unique military related finances.


If you liked this article, you might enjoy the following blog posts:

6 Mistakes Retired Military Officers Can Make That Could Mess-up Their Ultimate Retirement


Retired Military Finances 201:  1031 Exchanges


Retired Military Finances 101:  Taxes




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