People interested in planned charitable giving have been increasing asking: What is a donor-advised fund? Donor-advised funds (DAFs) are an increasingly popular way for investors to design a charitable donation strategy. It allows someone to take a systematic approach to distributing charitable dollars and realize significant tax deductions too.
According to the National Philanthropic Trust, grants made to charities through donor-advised funds amounted to $34.67 billion in 2020. This is an increase of 27% compared to 2019 and the highest increase in DAF grants in a decade.
Due to the Tax Cuts and Jobs Act enacted in 2017, use of donor-advised funds (DAFs) is soaring. Contributions to DAFs increased by 80% from 2015 to 2019, according to the National Philanthropic Trust (NPT). Grant-making from DAFs increased by 93% during that period. This article will look at how the donor-advised fund works and why it has become so popular.
What is a donor-advised fund?
A donor-advised fund is a private fund administered by a third party and created to manage charitable donations on behalf of an organization, a family, or an individual. DAFs give a wide range of donors access to tax and charitable giving advantages previously available only to those wealthy enough to set up private foundations. It makes planned charitable giving low-cost and convenient. In fact, many high-net-worth individuals use DAFs to avoid the costs and time needed to establish a foundation or charitable trust.
One feature that makes DAFs popular is that they can accept a wide variety of assets. These include cash, stocks, mutual funds, bonds, and complex assets such as private S and C corporation stocks, as well as nonpublicly traded assets like restricted stock, life insurance, Bitcoin and other cryptocurrencies.
How do donor-advised funds work?
Before setting up a donor-advised fund account, the giver must choose one of the many sponsoring organizations to work with. There are three types of DAFs: National, community, and public/single-issue funds. According to the National Philanthropic Trust, more than 900 DAFs are in operation, which gives investors a wide range of options for disposition of charitable contributions.
About 700 community foundations sponsor donor-advised funds. These charitable organizations are considered pioneers in DAF because they were the first to offer alternatives to checkbook giving and the complications of creating a private foundation. Community foundations typically appeal to donors interested in giving to local causes.
National DAF organizations
About 55 national donor-advised-fund organizations were operating in 2020. Some are the charitable arms of for-profit financial services institutions, such as the Vanguard Charitable Endowment Program, the Schwab Charitable Fund, and the Fidelity Charitable Gift Fund. Not all national donor-advised fund sponsors are affiliated with financial entities. These include the American Endowment Foundation and the National Philanthropic Trust.
Public/single issue foundations
These DAFs support national and international charities that focus on a particular issue or geographic region. Their personnel often have specific expertise to help donor-advised fundholders find causes that matter to them. For example, the Peace Development Fund houses donor-advised funds for individuals who care about creating systemic social change. Other public organizations, such as universities and hospitals, establish donor-advised funds to advance their charitable missions.
Setting up an account
Choosing a sponsoring organization and a DAF will depend on an individual’s personal interests and investment strategy. At this point, we should note that it’s wise to talk to a financial advisor before using a DAF to make charitable gifts. An expert advisor can help individuals make sure that a DAF blends in optimally with their estate and tax planning. The advisors also can help donors provide the maximum benefit to the charitable beneficiaries.
In addition to choosing the sponsor, investors will be asked to name the account, name successors should the primary grantor/investor pass away, and name beneficiaries. Additionally, they will be asked for input in the following areas:
- How is the money to be invested within the options offered by the fund?
- Which charities will receive grants from the fund?
- How much will be given to each charity?
- Who will make these decisions instead of the donor or as a successor to the donor?
One of the benefits of donating to a DAF is that you can take a tax deduction immediately, but donations can be postponed for years. While deciding which charities to support, your donation can grow and make more money available for charities. Most sponsors offer investment options that donors can choose from to grow their irrevocable contribution.
Indeed, while a donor can make many decisions about a DAF — investment strategies, amount, distribution timelines — they cannot take back the gift. The funds cannot be used for any purpose other than grantmaking to charities. Furthermore, although you can make suggestions as to which charities you would like to receive your distributed assets, the broker has the final say.
What are the benefits of a DAF?
Regardless of the sponsor, DAFs serve as tax-efficient giving vehicles. Before we go into detail, here’s a quick look at some of the benefits.
- No capital gains tax on long-term appreciated assets that are gifted
- Immediate tax benefits for the full market value of the gift for most assets
- No excise taxes, unlike a private foundation
- Assets donated are no longer part of the estate value
- No minimum annual distribution requirement for DAF account holders
- Help international nonprofits but receive federal tax benefits
Keep in mind that the tax benefits of donor-advised funds vary based on the type of contribution.
When donors contribute cash, or a check or wire transfer, they are eligible for a deduction of up to 60% of adjusted gross income (AGI).
For appreciated assets, donors can avoid capital gains taxes by giving the assets directly to a DAF instead of selling them and donating the proceeds. Also, donors can receive a tax deduction of up to 30% of their AGI for gifts of appreciated securities, real estate, mutual funds, and other assets. This is an area where a fiduciary advisor will come in handy.
Contributing assets to a donor-advised fund allows an individual to have their charitable assets professionally managed, but at a fraction of the cost of establishing and maintaining a private foundation.
Contributions made to donor-advised funds are tax-deductible in the same year they are made. This enables donors to deposit money into the fund when it will have the maximum tax benefit. That goes for when the fund is started and for any future additions to the fund. And the assets in these accounts are allowed to grow tax-free, which is valuable to the recipients.
Cope Corrales provides independent advisors, conflict-free proprietary investments, and strategies for a wide range of financial needs. Its tax and estate planning advisors act in a fiduciary manner to help clients make decisions about donor-advised funds and other philanthropy issues.