A donor-advised fund (DAF) is a private fund created to manage charitable donations on behalf of an individual or another organization. These funds are legally controlled by a sponsoring 501(c)3 organization. However, the donor is capable of making recommendations for how to invest and where to donate. Sponsors are the ones who have the final say, however.
While a DAF can help you out and also aid your community, it isn’t the right choice for everyone. If you’re curious about setting up a DAF, here are the basics you should know.
How They Work
You can contribute almost any non-publicly traded asset (such as stocks) to a DAF. This includes private stocks, mutual fund shares, cryptocurrency, or simply cash. These donations are irrevocable, meaning they cannot be returned or reclaimed.
These donations don’t sit idly, however. You can recommend an investment strategy to best help your donation grow. If your donation grows, more will be available for charitable works!
While the sponsoring organization makes the final decision, you as the donor can recommend any IRS-qualifying public charity to receive a grant from the DAF.
Benefits of Donor-Advised Funds
There are numerous benefits to donor-advised funds. You’ll need to compare these against the negatives to decide if setting one up is in your best interest.
Immediate tax deduction
When you contribute to a DAF, you are eligible to take an immediate tax deduction. This can in turn be invested for tax-free growth. Cash donations can receive a deduction up to 60% of your adjusted gross income, while long-term appreciated assets can receive a deduction of the fair-market value up to 30% of your adjusted gross income.
Lower capital gains tax
By contributing assets like limited partnership interests, donors can avoid capital gains taxes. These assets could accrue steep taxes if you realized them before donating. This way, the entire value of the asset can go toward a good cause, tax-free.
Full control over account
When you set up the account, you determine how it is going to be managed. You may not get to determine how the funds are used, but you retain a large amount of control when you establish the account.
You can incorporate donor-advised funds into your estate planning by making a bequest in your will or by setting up the sponsor as the beneficiary to a retirement plan, life insurance policy, or charitable trust. This allows you to support multiple charities with one bequest and can help reduce or altogether eliminate estate taxes.
Drawbacks of Donor-Advised Funds
As with any financial tool, there are also potential downsides which you should consider to decide if a DAF is the right option for you.
Because you receive the tax deduction immediately, the contribution is irrevocable. Once an asset is placed into the fund, it cannot be returned for any reason.
Donor-advised funds have no government-enforced deadline for distributing assets, which means that it’s possible for a fund to grow unreasonably large without doing much actual charitable work. Some sponsoring organizations mandate that donors disperse funds within as little as 18 months or as long as 10 years, but not all funds have a deadline.
Since using a DAF shelters that money from taxes, the idea that the money can then sit in an account for 10 or 100 years is upsetting to some advocates. Their concern is that the money put into a DAF is costly to communities because it’s not going to make it into government coffers or charitable organizations for an undefined period of time.
There’s also a built-in incentive for DAF managers to keep money inside the fund rather than distributing it. The larger DAF managers like Schwab and Fidelity take a management fee that increases as the size of the fund grows.
It’s very likely that federal agencies will add guardrails to the use of DAFs in the near future. Be sure to investigate the management fees and distribution rates of the DAF you choose before donating money. You might also like to know what type of compensation your advisor receives from the fund, if any.
Minimum fees and contributions
Most sponsoring organizations have varying investment fees as well as minimums for the initial or subsequent contributions to the DAF. This is on top of annual administrative and maintenance fees.
Are They For You?
Donor-advised funds aren’t for everyone. But they can have an immense impact on charitable causes, while also providing some nice tax benefits that you might not get from similar financial options. Contact us to reach an experienced financial advisor who can help determine if this is the right choice for you and your goals.