Why do you give money to charity? To help the people and causes that deserve help.
That should always be the guiding light of your giving decisions. If you end up giving money in a financially “sub-optimal” way…kinda, so what? You still accomplished the most important piece.
That said, there are several charitable-giving tactics that get the same number of dollars to charities while also improving your investment portfolio and taxes. Today, let’s discuss one such tactic: donating investments (technically, “appreciated securities”) instead of donating cash.
An “appreciated security” is simply an investment—mostly commonly shares of stock or ETFs or mutual funds—that has grown in value. So, instead of donating $10,000 in cash, you donate $10,000 shares of your Apple stock that has grown a bazillion percent since you bought it in 2013.
Doing this will save you in taxes. And while that’s fun enough by itself, what really revs my engine is that you can use those tax savings to easily improve your investment portfolio if:
- You own too much company stock.
- You no longer want an investment that you acquired a long time ago.
- You own a good investment that belongs in your portfolio…you just have too much of it.
If taxes didn’t exist, you could just sell the investment you didn’t want any more. But taxes do exist, so selling undesirable investments is painful and we’d rather avoid it, wouldn’t we. Donating investments helps us avoid it.
Lastly, even if the investment is good and you want all of it that you have, you can still improve your portfolio by donating it! It’s like magic up in here!
The Math that Shows How Donating Investments Is Better than Donating Cash
Let’s say you own 100 shares of stock XYZ (I mean this as a generic stock ticker, but dangit! This is what the-company-formerly-known-as-Square uses as its ticker!), worth $100 each (total value $10,000). You acquired this stock five years ago (maybe you bought it, maybe it was vested RSUs, maybe you exercised options, or maybe a rich uncle gave it to you) when it was worth $40/share. Of that $10,000 value, $6000 of it is taxable gains!
If you donate $10,000 cash, great. Deserving charities get $10,000. Maybe you’ll itemize your deductions and get some tax write-off for that $10,000; but the vast majority of people don’t itemize so you likely will end up getting zero tax benefit. The end.
If instead you donate these 100 shares of XYZ stock, deserving charities still get $10,000, the itemized deductions thing is the same, and you have saved an additional $1980 in taxes because you avoided having to pay taxes on the $6000 gains in XYZ stock.
See here:
Four Ways You Can Improve Your Portfolio by Donating Investments
You can use this ability to get rid of “appreciated securities” tax-free to improve your portfolio in several different situations.
If you own too much company stock
Have you been holding onto RSUs for years as they vest? Or did your company go public and basically overnight you acquired a bunch of company stock that you have just been staring at for a while now, paralyzed by indecision?
However it happened, your investment portfolio is now dominated by this one stock, and you don’t want it to be. But if you sell it, you have to pay a bunch of taxes. (Yes, for today’s purposes, I’m ignoring the variety of more complicated, less liquid, and/or more risky alternatives to selling.)
But wait! What if you donated a bunch of those shares of stock? If you do that, you can:
- Help deserving causes
- Reduce the “concentration risk” in your investment portfolio
- Lower your tax bill
Nice.
If you no longer want a specific investment
Maybe your dad gave you some shares of Amazon. Or maybe when you were first starting your investment journey, you bought a mutual fund that, now that you’re older and wiser, you’d never buy and don’t want to own anymore.
While the origin story is different, this is, in practice, exactly the same scenario as “owning too much company stock”: You own an investment. It has grown since you acquired it. You don’t want it. But to sell it would create a tax bill for you.
So give it to charity, with all the same benefits—to the charity, to your taxes, and to your portfolio—listed above.
If you own a good investment that belongs in your portfolio…you just have too much of it
If you bought an S&P 500 fund five years ago, it has grown 82% since then. If you haven’t been managing your portfolio, it has likely grown to dominate your portfolio.
In our example, you still want to own some S&P 500. You just don’t want quiiiite this much of it. You want to have a portfolio that is 40% S&P 500, and currently it’s at 60%.
This presents a great opportunity to “rebalance”—bring the balance of stocks and bonds in your portfolio back to the target balance—without having to sell anything (which creates a tax bill). You just donate some of your S&P 500 shares.
Now, this of course assumes you have a target balance of stocks and bonds. Without a target balance, you won’t know when you have “too much” or “too little” of an investment, and you won’t know what balance of each kind of investment you’re targeting. (At Flow, we accomplish this with clients by way of creating and annually reviewing and updating an Investment Policy Statement.)
If you own a good investment, and you want to keep all of it
Let’s say your portfolio is perfect just as it is. Just the right investments in just the right amounts.
Why would you donate (i.e., get rid of) some of these Just Perfect investments? I mean, it’s kind of a hassle, after all.
Because you can improve the tax characteristics of your portfolio.
How does that work?
Let’s say you donate $10,000 of shares with a cost basis (price you paid to acquire it) of $40/share. You then push your $10,000 cash into your portfolio (the $10,000 cash you still have because you didn’t donate it) and buy $10,000 worth of new shares, at a cost of $100/share.
In the future, if you sell these shares at $150, you have to pay taxes only on $50 of gain, not on $150 – $40 = $90 of gain.
Instead of Donating Cash, Invest It in Your Portfolio
Let’s continue to riff off of that idea of pushing $10,000 cash into your portfolio.
Donating $10,000 of investments leaves a $10,000 hole in your portfolio. Now, for some people, this is perfectly fine! They have enough money; they don’t need to worry about growing their wealth.
But if you don’t want to shrink your portfolio by using this tax-savvy donation technique, you can use that $10,000 cash that you didn’t donate to “fill” that hole.
You donate shares that you don’t want. You then use the $10,000 cash to buy different investments that your portfolio needs. This is another opportunity to “rebalance” your portfolio.
By doing this, your portfolio is no smaller for your charity, and your portfolio is doubly better off because you removed investments you didn’t want and bought more investments that you did.
I just think that’s so cool.
If you don’t have a spare $10,000 cash sitting around, maybe you can save an extra $1000 to your taxable account each month. In 10 months, voila! You’ve filled that $10,000 hole left by the donation.
Important notes to make sure you do this right
It’s the financial industry and the IRS…of course there are 100 fiddly things to know in order to do this right. The most important, in my opinion, are:
You must have owned the investment for at least one full year before donating it.
The investment must have a gain in it. If it’s at a loss, especially if you don’t want it, just sell it and get a tax write-off that way.
This only works if you own investments in a taxable account. If all your investments are inside your 401(k) or IRA…sorry, bub, no can do. But hey! What a good reason to save and invest outside your 401(k)!
Donating appreciated stock to a charity is harder than just giving them your credit card number. If you’re donating stock to multiple charities, the hassle starts to build. I’d investigate donating your appreciated stock to a Donor Advised Fund first. From the DAF, you can immediately sell the investment to cash (with no tax bill) and then grant cash to a bunch of charities easy peasy.
I love giving money to charity. I love seeing clients do it. Do it just for the sake of helping others. But when you start talking about how it interacts with your investments, you have to have a plan for what your investments should look like. If you don’t have an investment plan (it really can be quite basic), then you’re executing tactics in the absence of strategy. I’m sure there’s a military analogy here that would illustrate just how bad that is. TLDR = Have an investment plan.
Now, go forth and be charitable.
Do you already give money to charity, and you’d love to do it in a way that can now help improve your investments and your taxes?
Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.
