WASHINGTON — A donor-advised fund (DAF) is a powerful and popular tool to simplify the management of your charitable giving. According to the 2017 Donor Advised Fund report from the National Philanthropic Trust, donor-advised funds reached a record $23 billion in contributions in 2016.
Donor-advised funds offer many of the benefits of a private foundation without the headaches. Some of the advantages are that it allows you, as the donor, to receive an immediate tax deduction for the full amount of your charitable donation, invest the principal free of taxes and distribute funds to charities that you and your successors care about most over time.
Establishing an account in a DAF can be arranged at most major brokerage firms, as well as through community foundations and single-issue charity sponsors. The initial amount needed to open a DAF account and the required future minimum additions and charity gifts varies based on the specific sponsor. Other than your donation into the fund, the detailed substantiation paperwork for your gifts to underlying charities is eliminated. A DAF provides you the paperwork or website access to support your additions as well as research links for 501(c)(3) charities that you may choose to support.
Under the new 2018 tax law, you may benefit by contributing to a DAF in alternating years to assure that you can itemize deductions. As long as you itemize deductions on your income tax return, you can write off the amount you contribute to your DAF account as a charitable contribution for that same year. Be aware that a donor cannot receive any personal benefit (i.e., goods and services), such as a charity dinner or ticket, in exchange for a donation from a DAF. Once funds go into a DAF, they cannot be retracted for or by the donor — the charitable gift is irrevocable.
Here are the answers to a few of the most frequently asked questions to help you better understand this charitable giving vehicle:
Who are donor-advised funds right for and what’s the ideal way to utilize them?
- DAFs are a tool that can be right for anyone wishing to maximize their charitable giving, be tax-smart and streamline the administration of gifts. Like many other advanced planning devices, there’s no one ideal way to utilize them — they’re flexible enough to custom fit to a donor’s overall advanced-planning strategy. However, if your average donation is under $50, or the initial contribution would be under the minimum of the DAF provider, then a DAF may not be a good fit. Many of the larger national DAF providers such as Schwab Charitable and Fidelity Charitable require a minium donation amount of $5,000 to set up an account and minimum gift to any charity of $50.
- They may be right for someone who’s looking for a charitable deduction in the current year — perhaps because it’s a windfall high income year, their income is “lumpy” from year to year, or they want to front-load donations in order to itemize deductions — but would like to take their time distributing the assets to the charities of their choosing. Perhaps they even want to pass on a charitable legacy to future generations.
What are some of the best benefits of DAFs?
- Donors receive an immediate tax deduction when they make a charitable contribution to a donor-advised fund even though the actual gift may not be granted to a 501(c)(3) public charity until a future year.
- Contributions into a DAF are invested and grow tax free. Many providers offer a range of investment options such as pre-allocated investment pools, mutual funds (both passive and actively managed), exchanged traded funds and money market funds, to name a few.
- Convenience, simplicity and reduction of workload/paperwork involved with donations throughout the year and tax compliance at the end of year.
- The ability to give long-term (i.e., owned for at least one year) appreciated securities or complex assets like private business interests, private company stock, partnership interests, real estate and life insurance one time and then parcel the donations out to more than one charity; the ability to contribute complex assets to a DAF will vary by the provider.
- Flexibility to give anonymously or with full/partial recognition. There are times when donors feel anonymity is appropriate and works with their overall values system.
- DAFs can help donors diversify their investment portfolios. Some investors retain concentrated stock or other positions because they don’t want to recognize the gains. Some also make charitable donations with cash. It’s possible to donate all or a portion of these appreciated securities to a DAF, and then sell the position from within the DAF without having to pay tax on the gain. The proceeds can then be invested in a manner appropriate for the investor’s future charitable giving plan.
- The donor can choose the name for their DAF account and use this name or their own name for recognition purposes. Or, they can choose to remain anonymous.
- Many families establish DAFs as a way to foster charitable giving at young ages and establish a perpetual legacy family fund. Many DAFs offer online links and charity research tools to help you better evaluate charities of interest together as a family.
What are some common misconceptions about DAFs?
- That the donor or their adviser can’t control how the assets are invested after they’re contributed to a DAF; in fact, many DAFs have a robust investment platform.
- That complex assets (such as closely held company or partnership interests, real estate, or life insurance) aren’t eligible for contribution to a DAF; again, while not all providers can handle these contributions, some can. It’s important to have these types of nontraditional assets reviewed and approved in advance by the sponsor.
- That the DAF ends when the donor dies. It’s possible to name successor advisers, such as your adult-aged children, and/or designate one or more charitable organizations as account beneficiaries.
- That a certain dollar amount must be distributed by the donor-advised fund each year. Unlike a private foundation or charitable trust, there is no IRS-required annual distribution requirement on how quickly the money has to be distributed. Providers may have their own requirements, however.
- That DAFs are difficult to set up or costly to administer; yes, DAF sponsors typically charge annual administrative fees for record keeping, providing donor support, and tax compliance. However, the larger DAF sponsors charge administrative fees in the range of 0.6 percent to 1 percent of your asset balance and offer lower breakpoint pricing for higher asset balances. Investment management fees vary depending on the type of investments selected. Index mutual funds tend to have very low expense ratios; actively managed funds may have expense ratios of 1 percent or higher, similar to non-DAF investment portfolios.
- Most people don’t realize they can move from one DAF provider to another DAF provider (e.g., from a community-fund-sponsored DAF to a commercially available or religious-organization DAF) but you should confirm this in advance of any transfers.
What key IRS guidelines should be kept in mind when considering a DAF?
- The asset valuation used for the charitable deduction for long-term appreciated securities, closely held stock or real estate is the fair market value of the security, not the cost basis (unlike for a private foundation).
- The income tax deduction limit as a percent of adjusted gross income (AGI) is 60 percent for cash donations and 30 percent for gifts of appreciated assets. There is a five-year carryforward deduction on donations that exceed these AGI limits.
- Donors must not receive any personal benefit (i.e., goods or services) from the grant-making activity or charitable donation. The biggest trap is often the benefits received when a donor participates in charitable golf outings, galas, silent auctions or similar activities.
- DAFs are ineligible to receive direct IRA rollover contributions. Therefore, donors taking required minimum distributions (RMDs) from their retirement accounts are not allowed to send the RMD directly to a DAF as a qualified charitable distribution.
Advanced planning with DAFs
Many of the larger DAF sponsors are prepared to accept gifts of select non-publicly traded assets, such as private company stock, partnership interests and real estate. However, debt and other “hot assets” need to be taken carefully into account to determine any negative tax consequences to both the donor and the DAF. A properly constructed contribution of these interests to a DAF can often result in:
- A charitable deduction at full fair market value
- No income taxes when the DAF sells the underlying property
The DAF is best suited for interests that will be highly marketable in the near future. Prime candidates for contribution are pre-IPO stock and businesses considering (but not necessarily in contract for) a liquidity event. Your attorney, financial planner and tax adviser, along with a valuation firm, will need to team with the DAF to ensure optimal tax results for these complex gifts.
- Seek professional assistance: Consult with your wealth- and tax-advisers to help get the full benefit of a DAF for your situation. It’s a powerful tool, and it can be advantageous to work with professionals to maximize its potential.
- Stop gifting cash! Many donors forget (or don’t know) the tax benefits of gifting appreciated securities. Using a DAF as a conduit in this regard can simplify the process and allow charities that can’t accept asset donations to benefit.
- DAFs can make charitable giving fun for the whole family and educational. It’s not uncommon for parents or grandparents to use DAFs to teach or reinforce family values. They can be used to teach important initial lessons about money and create a positive bonding vehicle across and among generations.
Donor-advised funds can be a convenient, cost- and tax-effective vehicle to support your favorite charities. Keep these questions and answers in mind to help you make the best decision to support your charitable legacy.
Nina Mitchell is a principal and senior wealth adviser at The Colony Group, and co-founder of Her Wealth®. Max Haspel is a principal, Managing Director and senior wealth adviser at The Colony Group. Nadine Gordon Lee, CPA/PFS, CFP® is Managing Director, NY Metro Offices & President, Colony Family Office Group at The Colony Group.