This article was originally posted in September 2017 and has been updated on December 29, 2021, to reflect new changes.
What is a Donor-Advised Fund?
Donor-advised funds (DAFs) go by many names. They are called charitable gift funds, charitable funds, giving funds plus others. For this article, I will refer to them by their legal definition, Donor-Advised Funds (DAFs). A DAF is a fund maintained and operated by a sponsoring charitable organization that has legal control over the funds.
How Does a DAF Work?
- An individual, or donor, contributes cash or securities to a DAF account. Stocks and bonds are commonly used for funding. Some DAFs may accept real estate, restricted stock, and non-publicly traded securities as well. A minimum contribution is required and many of the larger DAF sponsors require minimums between $5,000 - $25,000.
- The donor chooses pooled investments similar to mutual funds, called investment pools. The investment pools are usually broad-based asset classes such as U.S. Stocks, International Stocks, or U.S. Bonds. There may even be investment options that utilize environmental or social screens. Funds grow tax-free in the investment pool.
- Donors direct the donations, called grants, for as little as $50 to IRS-approved charitable organizations. According to Guidestar, an organization that tracks non-profits, the IRS recognizes over 1.8 million tax-exempt organizations. So, many organizations are eligible to receive funds.
- The donor takes a charitable tax deduction in the year the contribution is made. Up until the tax year 2019, if cash was used for funding, donors were eligible for an income tax deduction for up to 60% of adjusted gross income (AGI). But due to the pandemic, Congress has been enacting legislation increasing the limits for cash donations, in some cases even up to 100% of AGI. When funding with securities, donors may be eligible for an income tax deduction for the full market value of the securities, up to 30% of adjusted gross income. Also, keep in mind the donor will not pay any capital gains taxes to sell the securities. Note: Due to the pandemic response, legislation and economic policy have been changing in 2020 and 2021. Check with your advisor or accountant to receive the most recent tax policy deductibility limits.
DAFs are easy to set up and reporting is minimal. Tracking your contributions and grants is simple since they are in one place. You can contribute when it is convenient for you but can direct donations over time. A number of our clients have positive experiences using both Schwab’s Donor Advised Fund and Fidelity’s Donor Advised Fund.
Due to their flexibility and ease of use, DAFs have been growing in popularity. Contributions in 2019 totaled $31.81B representing 12.7% of total giving. Grants totaled $27.37B. Their contributions and grants are outpacing overall giving and assets now stand at $141.95B, up 16.2% from the previous year.
Source: National Philanthropic Trust
Americans have a history of charitable giving, it’s a part of the fabric of our culture. Many public institutions such as schools, hospitals, museums, and parks, owe their existence to charitable donors. According to Giving USA, Americans gave $449B to charities in 2019. And it goes up almost every year. More and more of those donations are coming from Donor-Advised Funds.
Funding a DAF allows some unique opportunities to progress a donor's financial plan and goals. This is because donors control the timing of funding and securities are an option for the contributions. Here are some funding strategies to consider:
Low-Cost Basis Stock
Many investors own low-cost basis stock and are reluctant to sell and incur large capital gains taxes. Donating stock to a DAF allows the donor to take a tax deduction and avoid capital gain taxes. You don’t have to do it all at once either but can contribute over time. Often, the donor can give 20% more to charity than by selling the security first and donating the after-tax proceeds. This allows the double benefit of avoiding capital gains taxes and gifting more to charity. Everyone wins!
Concentrated Stock Holdings
If an investor has a concentrated stock holding and is trying to diversify a DAF is a tool to consider. As opposed to selling and incurring gains, contribute concentrated holdings to a DAF. For executives and heirs holding a large stock position, this is a great way to diversify.
Vesting Stock Options
Many times, when a publicly-traded firm is acquired by another company, the stock options of the acquired firm automatically vest. This is a great windfall for the employees who own them but it creates a big tax bill for the year. Often, it bumps the employee into a higher tax bracket and taxes take a big chunk out of proceeds. The one-time windfall is an opportunity to fund a DAF to offset higher taxes and ensure future giving.
The 2022 standard deduction is $12,950 for single filers and $25,900 for those married filing jointly. That is almost double the previous standard deduction prior to the tax law changes. Therefore, more tax filers will benefit by using the standard deduction instead of itemizing deductions. Charitable contributions are included in itemized deductions, so the tax deduction is lost if you take the standard deduction. Those who are close to benefiting from itemizing can utilize a DAF and itemize with higher deductions some years. For example, if someone usually donates $5,000 every year to charity, but they need to donate $10,000 for it to make sense to itemize they can “bunch” their contributions for two years into one year and donate $10,000 to a DAF. They can pay the $5,000 of donations out over two years as usual but itemize in the year of the contribution, thereby lowering their tax bill for that filing year. Note: Congress passed legislation allowing individuals who don't itemize deductions a deduction of $300 for cash contributions made during 2021 and married couples filing jointly are allowed $600. Check with your advisor or accountant on the most recent tax policy deductibility limits.
Many executives and professionals receive annual bonuses comprising a large part of their income. There are big bonus years while other years are a little leaner. A big bonus allows a larger contribution for that year. This provides contributing evenly on an annual basis, even in lean years.
A DAF can also be funded by being named as a beneficiary from a retirement account, life insurance policy, trust, or will. This allows the donor to fulfill philanthropic goals using proceeds from their estate.
How to Use DAFs to Fulfill Personal Goals
DAFs are also great for fulfilling personal goals. Here are a few possibilities:
A Teaching Tool for Future Generations:
For parents and grandparents trying to instill values in the next generation, a DAF can help. Parents or grandparents can create a fund for the whole family. Everyone can have a role in directing donations. With so many organizations eligible, conversations can include global charities like the World Wildlife Fund or local ones like the YMCA. And it works for almost any age, whether the next generation is 5 or 35.
Donors usually have flexibility with naming the DAF account. The account can be named after the family to reinforce the family’s charitable efforts, such as The Jones Family Charitable Trust. And the next generation can be named as successors on the account to carry on the family tradition of philanthropy.
At the Smith household, we have done this for years. Every December, we gave our kids $50 or $100 to donate to any charity. We wanted them to think of others during the holiday season. It was wonderful to see how their choices changed over the years and always provided great conversations.
Honoring a Loved One
A loved one can be honored in the name of a DAF account. It can be in the name of someone who did a lot for charity or an organization. Grants in their name can keep going to their favorite causes in remembrance of them.
An account can also be named after a loved one who passed due to an illness or tragedy. Sending donations in their name allows something positive to come out of unfortunate events.
Board Members of Charities
Board members are usually the strongest proponents and supporters of their organization. Along with giving time and expertise, they are often the biggest financial supporters as well. There can be expectations to donate annually, as well as during a time of need. Sometimes the timing for giving may not be convenient, so in steps the DAF. The Board member can have funds at the ready for when there is a cash crunch or opportunity. It will allow them to show leadership despite the timing.
Donors must be careful when directing grants so that they do not receive any goods or services. Only items deemed incidental, such as a t-shirt, may be acceptable. The donor can be penalized if a grant results in an impermissible benefit.
A donor cannot take a tax benefit due to a grant. The donor was allowed a tax break during the year of the contribution. This is true, even if the investment pools have grown substantially. No double-dipping on tax deductions!
There are fees involved. The investment pools have management fees and administrative fees may apply as well. Make sure the fees are acceptable. The lower the fees, the more funds left for your grants.
Donor-Advised Funds are not eligible to receive Qualified Charitable Distributions (QCDs) from IRA accounts. IRA investors age 72 who have Required Minimum Distributions can utilize QCDs to reduce their taxable income. Utilizing a QCD instead of funding a DAF may be your best option. To learn more about QCDs, read: Using an IRA QCD: Consider Giving Your IRA RMD to Charity.
If you want your financial advisor involved to direct investments or grants, choose one that allows that option.
Lastly, there are other vehicles to consider for charitable giving. Charitable trusts or individual foundations may be a better option even with higher costs and complexity. But a DAF can complement a trust or foundation as well, it doesn’t have to be all or nothing. For those with higher assets and complex financial situations, involve your estate attorney, CPA, and financial advisor. They can work together to craft the best options for you.
Donor-Advised Funds are an easy, flexible, low-cost way to gift to charities. There’s potential for tax breaks, tax-free growth, and financial planning opportunities. They are a great option for many to fulfill their planning and philanthropic goals.
Disclaimer: The information in this article is for educational purposes only and is not to be construed as financial planning advice. Please seek individual guidance from your accountant or financial advisor before opening a Donor-Advised Fund account.