Charitable giving is one of the most meaningful uses of money. Many people who start investing early in life will be in a position to give throughout their career and during their retirement years.
It's important to approach charitable giving with pure motives. But it should also be noted that givers can enhance the effects of their giving by using tax-optimization strategies.
The donor-advised fund (DAF) is one tool that givers may want to employ to maximize their giving potential. We explain when it makes sense to use a DAF and how to effectively fund and give from it.
What Is A Donor-Advised Fund?
A donor-advised fund (DAF) is an investment account where 100% of the proceeds are legally required to go to charitable organizations. Investors who use DAFs take an upfront tax deduction when they contribute to a DAF, but the funds can be distributed at a later date.
Assets put into a DAF are technically owned by a sponsoring organization (for example Vanguard Charitable, Fidelity Charitable, Schwab Charitable, or National Philanthropic Trust). Typically, these organizations only give funds to organizations as directed by the donor. However, they may have rules that require a minimum number of gifts per year.
Individuals, couples, families, companies, and trusts can all have a donor-advised fund. The fund can make grants to all publicly-recognized charitable organizations.
Pros Of Donor-Advised Funds
Using a donor-advised fund to give charitably can be an excellent option. These are a few reasons to consider a DAF.
Donate Funds In A Tax-Efficient Manner
People who use donor-advised funds often contribute appreciated assets to the fund. By contributing appreciated assets, the account owner avoids paying capital gains taxes on the asset and they get to claim a deduction for the contribution.
Charitably-inclined individuals may also set up a DAF when they have a large windfall. For example, someone who sells a business or receives stock options may contribute funds in one lump sum. This maximizes the deduction for a given tax year while allowing that person to direct funds over several years.
Funds Can Remain Invested For Growth
Assets within a DAF can be invested for growth until the donor gives them away. This is especially useful for people who want to plan annual contributions for several years.
DAFs Simplify Record-Keeping
Donor-advised funds typically have a “grant-giving” function. They allow filers to give financial gifts to charitable organizations. With this function, givers don’t have to track each gift they give. Instead, they can track the receipts generated by their DAF.
Very High Maximum Donation Thresholds
Donors can contribute up to 60% of their adjusted gross income (AGI) in cash to a DAF, or 30% of their AGI in appreciated assets. This limit allows people to give large lump sums without committing to specific charities at the time of giving.
Cons Of Donor-Advised Funds
While a donor-advised fund is useful for tax optimization, it’s not always a great tool. These are a few reasons givers may want to stay away from DAFs.
Only Useful For High-Income Or High Net Worth People
People with high incomes or large asset bases can take full advantage of a DAF's tax-optimizing power. But it's not a great tool for people who want to give a few thousand dollars each year. The average person won't benefit from the added complexity.
Funds Are Inaccessible In An Emergency
A donor-advised fund works “as-if” the money in the account has already been donated. Investors cannot take money out of the account for personal use, even in the event of an emergency. Donors should only contribute money that won’t be needed in the future should go to this account.
Delays Giving Charitable Gifts When Funds Are Available
Many charities can handle large gifts and they need the funds to continue operating. Contributing to donor-advised funds delays getting the funds into the hands of charities. In many cases, the giver gains tax advantages, but the charities don’t get money for years.
Some Donor-Advised Funds Have High Expenses
Historically, DAFs had high maintenance expenses. While a few companies (such as Charles Schwab, Fidelity, and Vanguard) have lower-cost options, givers need to look out for the fees.
May Have Minimum Giving Restrictions
Sponsoring organizations can place restrictions on grants given from DAFs they sponsor. For example, most have minimum gift thresholds ranging from $50-$500. The sponsoring organizations may also require a minimum frequency for issuing grants.
Contribution Minimums Can Be Prohibitively High
Some brokerages have very high initial investment and additional contribution minimums. Vanguard, for example, has a $25,000 initial contribution minimum. Charles Schwab and Fidelity, however, have no minimum requirement.
All Gifts Must Be To Recognized Non-Profit Organizations
Donor-advised funds must contribute to recognized 501(c)(3) organizations. Right now, the definition of these organizations is broad. It includes:
- Religious organizations
- Scientific organizations
- Sports and recreation organizations
- Schools
- Literary charities
- Medical and public safety organizations
- And much more.
With so many eligible organizations, DAFs currently offer a lot of flexibility. However, laws governing this could change and your preferred organization may no longer be fundable in the future.
Funds Technically Belong To A Sponsoring Organization
A donor-advised fund’s sponsoring organization technically owns the assets in a DAF. In practice, most sponsoring organizations will direct funds however the donor wants to give the funds. However, the organization could technically go rogue and give to any charitable organization it prefers.
DAF Contribution Strategies
If you think a donor-advised fund is right for you, these are a few strategies you might want to use to fund the account.
Fund Now, Give Later
During a high-income year (or years), a charitable person may choose to contribute to a donor-advised fund. During lower-income years, this person can continue giving charitably through grants from the DAF.
This is an especially useful strategy for high-income individuals who plan to retire within a decade. It could also be a good option for people who are receiving windfall income (for example selling real estate or a business).
Donate A High-Flying Stock
Contributing an appreciated asset to a DAF maximizes your tax deduction while eliminating capital gains taxes. Givers can even re-buy the stock in their regular portfolio at a higher price point.
Rebalance Into A Donor-Advised Fund
Investors who regularly rebalance a regular brokerage account sell high-performing assets to buy less expensive investments. Rather than selling the high-performing investments, an investor may choose to donate some or all of the appreciated assets. This leads to tax savings on the capital gains even if a person won’t be able to itemize their taxes in a given year.
Recurring Contributions
People with very high incomes may want to put a set percentage of their income in a donor-advised fund each year. This will allow them to give now and save to give in the future. Automatically contributing from cash flow can ensure that the DAF gets funded to its full potential.
DAF Giving Strategies
While contributions drive tax savings, donors should also have a giving strategy to ensure that the assets in the DAF do the most possible good in the world. These are a few giving strategies to consider.
Give A Percentage Of The Account
Donors may want to give a set percentage of their account balance each year. For example, you may choose to give 5-10% of the portfolio each year. When the portfolio declines in size, the giving declines with it.
Create Recurring Grants
Donors may choose to give recurring grants to their preferred charities. For example, a donor may give $10,000 annually to their church and $10,000 to a local food shelf. The DAF can give these funds in perpetuity until the assets run out. These gifts can also be based on a percentage of the total portfolio.
Get The Family Involved
Donors can build a charitable legacy by encouraging their children and grandchildren to be involved in the grant-making process. The donor can add secondary advisors to an account. These advisors can be trained in grant-making and they can take over the account when the donor is unable to manage it any longer.
Where To Open A Donor-Advised Fund
If you’re interested in opening a donor-advised fund, you'll need to select a “sponsoring organization” which is like a brokerage.
The chart below shows the types of assets that each organization accepts, the minimum initial contribution, and the minimum gift size. We also list the range of annual account fees. These factors are likely to influence which sponsoring organization suits your needs best.
Header | Assets that can be added to an account | Minimum initial investment | Minimum grant | Fees |
|---|---|---|---|---|
Cash, stock, real estate, private equity, private stock, collectibles, restricted stock, crypto | $10,000 | $250 | 0.10%-0.85% | |
Cash, stock, private equity, private stock, real estate, crypto, restricted stock, life insurance | $0 | $50 | 0.10%-0.60% | |
Cash, stock, private equity, private stock, restricted stock, life insurance, crypto | $0 | $50 | 0.15%-0.60% | |
Cash, stock, bonds, mutual funds, complex assets are handled on a case-by-case basis. | $25,000 | $500 | 0.05%-0.60% |
Alternatives To The Donor-Advised Fund
Not sure that a DAF is the right vehicle for optimizing your charitable donations? Here are a few other tax-efficient giving options worth considering.
Qualified Charitable Distributions
People aged 70.5 and older can make distributions from their IRA to the charity of their choice. QCDs are excluded from taxable income, making them a great tax-advantaged option for everyday people with retirement accounts.
Bunching Gifts
People who give several thousand dollars every year may choose to increase the tax efficiency of giving by bunching two or more years of giving in to a single tax year. This strategy is often referred to as "superfunding."
For example, a couple that gives $15,000 annually cannot itemize their taxes. But if they give $30,000 one year and $0 the next, they can itemize during the year they contribute $30,000.
Give What You Can Regardless Of The Tax Implications
Developing a charitable giving habit when you’re earning less money will help you give more when you have more to give. Even if you can’t give in a tax-efficient way now, consider giving a percentage of your earnings to develop your charitable giving muscles. As your income and assets grow, you can re-evaluate how to give in the most tax-optimized way possible.
Final Thoughts
A donor-advised fund is an excellent tool for increasing the tax efficiency of giving, especially if you’re entering the highest income years of your life. It can allow givers to donate now and give recurring gifts throughout their lifetimes and into the next generation.
But the DAF isn’t necessary to start giving. If you’re not a good candidate for a DAF, don’t let it stop you from giving now to make the world a better place.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared toward anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications, including the New York Times, Wall Street Journal, Washington Post, ABC, NBC, Today, and more. He is also a regular contributor to Forbes.
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