Charitable Giving In A Volatile Market
During times of extreme market volatility and economic distress, maintaining your long-term perspective can be challenging.
Weathering market volatility
For most of the past decade, the key to getting through unexpected turbulence is to understand that swings in the financial markets are normal—and relatively insignificant over the long haul.
During times of extreme market volatility and economic distress, however, maintaining your long-term perspective can be challenging. We’ve seen recent market reactions that have driven an unprecedented number of circuit breakers to halt trading.
Charitable strategies during periods of market volatility
Many people donate to charity by mailing a check or charging a donation to their credit card. However, donating cash is not necessarily the wisest strategy to maximize both your tax benefits as well as the amount of money available for your favorite charities. Your financial advisor or a charitable planning specialist with Fidelity Charitable can help educate you about the most efficient ways to support your favorite charities, while potentially reducing your tax burden. The following are some common scenarios that occur regardless of the market environment and your charitable giving decisions should be coordinated with portfolio management decisions. These strategies pair well with making a donation to a public charity that sponsors a donor-advised fund program (DAF) which qualifies for tax deduction for your contribution while allowing time to plan out an effective giving strategy for the future.
The case for stocks
Despite the recent market volatility, the current value of many of your investments may still be significantly higher than when you purchased it, given the long-term gains over the past decade. By donating long-term appreciated stock to a charity, including charities that sponsors a donor-advised fund (DAF) program, you will generally be eligible to take a tax deduction for the fair market value of the contribution, and potentially eliminate capital gain tax rate of 20% and the potential of Medicare surtax of 3.8% that you would have otherwise incurred on the sale of the stock.1 Compared with donating cash or selling your long-term appreciated securities and contributing the after-tax proceeds, you may be able to automatically increase your gift and your tax deduction.
1This assumes all realized gains are subject to the maximum federal long-term capital gain tax rate of 20% and the potential of Medicare surtax of 3.8%. This does not take into account state or local taxes, if any.
The right time to rebalance…and give to charity
Despite recent market volatility, portfolios may still need a rebalancing strategy as a result of the decade-long bull market. When a portfolio is over-weighted with equities, vulnerability to stock market corrections increases. Reducing exposure typically means selling appreciated positions, which generally triggers a capital gains tax liability.
Rather than selling the appreciated positions to rebalance your portfolio, consider donating a portion of them to a charity. Aligned with the strategy noted above, you can receive a double benefit: you are generally eligible to claim a charitable deduction for the full fair market value of the asset and can potentially eliminate the capital gains tax.
Offset a high-income year
If you experienced a particularly high-income year, perhaps due to stock option exercises or the sale of a business, donating to a DAF sponsor can reduce your taxable income. This may be especially helpful if you’re on the brink of moving up into a higher tax bracket. Remember that donating to a DAF sponsor means that you can donate now and in the future. And with a DAF, your contributions may be invested and may have the opportunity to grow tax-free, which could result in additional dollars for charitable grants.
Managing the sale of privately held interests
When deciding which asset to donate to a charity, you and your advisor should seek to identify a long-term appreciated assets. Rather than donating a security that—due to market turmoil—may be trading at a depressed price, look across your full portfolio for other options. This may include privately held C-corp or S-corp shares or limited partnership interests. Donating these assets to charity—especially when you donate them to a DAF sponsor—may enable you to avoid long-term capital gains on the sale of the assets. You will also be entitled to a tax deduction on the full current market value of the assets, rather than the original cost basis. As with other types of DAF donations, the highest possible percentage of funds from the sale will be available for grant recommendations to charity.
Make the most of changing legislation
The SECURE Act eliminated the “stretch IRA”, which allowed non-spousal beneficiaries to withdraw assets of inherited accounts over their lifetimes. Now, those who inherit an IRA have 10 years after the death of the original account holder to withdraw the assets. However, all is not lost. If market volatility has resulted in a lower balance within your retirement account, this is a ripe opportunity to convert a traditional IRA or 401(k) to a Roth IRA. Roth IRAs allow you to set aside after-tax income, so you will incur income tax on the balances you convert from traditional IRA to a Roth IRA. Offset some of the remaining taxes you could incur by making a charitable gift to a DAF sponsor. To ease the tax burden even further, consider frontloading multiple years of gifts into this year. As the market recovers, not only will you be on the tax free side of the equation with your IRA, but your charitable gift has the potential to grow and even exceed the original gift- allowing you to give more to the causes you care about. 2
2If you are considering making a qualified charitable distribution (QCD) from an IRA account, remember that some charities are not eligible recipients. This includes donor-advised funds, private foundations and supporting organizations as described in IRC Section 509(a)(3).
Rebalance asset allocation for continued alignment with your philanthropic goals
For those who already have a DAF, thinking about investments within a DAF is very similar to thinking about any personal account that you may have. There is a sum of money to be invested, a timeline and a goal in mind. What’s different is the ultimate purpose: with a DAF, you are in the unique position to grow a gift to charity in a tax-free setting, possibly providing much more money to charity over time. But it’s still about setting a goal and diversifying with a suitable asset allocation to help you meet that goal in the long-term. Historically, major asset categories have not always moved in sync. Market conditions that cause one asset category to have strong returns often cause other asset categories to have average or poor returns. Investing in more than one asset category helps mitigate risks of this inevitable market volatility. Rebalancing can help make extreme downturns less painful, which can, in turn, help you stay invested and ultimately meet your philanthropic goals.
Final thought
Remember that market volatility is an inevitable part of investing and managing wealth. Tuning out the short-term noise can help you weather the storm and keep your eye on your long-term goals. If you decide that portfolio changes are necessary, remember to incorporate charitable planning into your discussions with your financial advisor or a with charitable planning specialist with Fidelity Charitable.