Financial advisors have touted the benefits of donor-advised funds for years, but it’s safe to bet most small investors think this approach to charitable giving is for the well-to-do.
But big firms like Vanguard, Fidelity and Schwab cater to the common investor with products that don’t require a king’s ransom to get started.
“The Vanguard, Fidelity and Schwab donor-advised funds are able to offer fund management and donor record-keeping services at lower cost through economies of scale,” says Dave Louton, finance professor at Bryant University in Smithfield, Rhode Island. “This is just the mutual fund formula reinvented and applied to philanthropy. These are reputable firms that have identified significant demand in a niche market and have brought their specific expertise to the challenge of meeting that demand.”
The higher your tax rate, the more you benefit from the tax deduction on charitable contributions. So, with Congress now likely to approve substantial tax cuts to take effect in 2018, many investors may want to cram the next few years’ worth of contributions into 2017.
Donor-advised funds allow the giver to claim a tax deduction the year money is put in but then let the giver parcel the contributions and investment gains to his or her choice of recipients over as long a period as desired, with no tax on the fund’s growth, providing a low-fee alternative to setting up a foundation.
[See: 7 of the Best Stocks to Buy for 2018.]
In 2016, donors put about $23 billion into donor-advised funds, up from about $14 billion in 2012, according to a report by the National Philanthropic Trust.
But the report says the average fund contains about $300,000, suggesting donor-advised funds appeal to well-heeled donors, though not the super-rich. Many givers have used these funds set up specifically for them by financial experts, or have chosen funds offered by national charities, community foundations or single-issue charities.
Donor-advised funds aren’t perfect. There are fees, and givers typically have some investment restrictions.
“The biggest pitfall with a DAF is the lack of control,” says Patrick Huey, owner of Victory Independent Planning in Camas, Washington. “It is a donor-advised fund, after all, not a donor-managed fund. While, in reality, this provision is meant to keep donors from contributing to non-qualified charities, this perceived lack of total control can be nerve-wracking for some investors. They must weigh the current tax deduction against the control of assets in their overall financial and retirement plan.”
Still, Huey says a donor-advised fund “is an excellent tool, especially for clients who don’t want (or can’t afford) the administrative costs of a family foundation but are charitably inclined and in need of a current tax deduction beyond what they would receive through annual giving.”
Donors should also remember that although the fund may live on for many years, it is no longer theirs.
“Donors should not lose sight of the fact that gifts to donor-advised funds are irrevocable, so they are no longer part of the donor’s personal wealth,” Louton says. “This is the price of tax deductibility, but it may be easy to forget because of the degree of influence over the ultimate disposition of the assets that the donor retains after making the gift.”
The new products from financial services firms aim to open the doors to ordinary folk by requiring relatively small contributions to open an account. Vanguard Charitable requires $25,000, Fidelity Charitable and Schwab Charitable just $5,000. All three charge a 0.6 percent annual administrative fee on top of expense ratios of the funds they provide.
With a donor-advised fund, you don’t have to decide up front where you want your money to go. You have time to watch prospective charities, think it over and adjust as the need for philanthropic gifts changes — like when a natural disaster strikes.
For many years donor-advised funds have been set up through financial advisors, with provisions like investment options tailored to the individual donor. Now offerings from firms like Vanguard provide a low-fee alternative.
[See: 7 Socially Responsible ETFs for Investors of All Stripes.]
Using this new breed of donor-advised fund, you can still designate the charities of your choice. But the investment options are not as wide open as with a fund tailored to your specific preferences.
Vanguard Charitable has several bundles of mutual funds ranging from very conservative, aimed at preserving capital, to a riskier all-stock option intended for more growth. Each bundle contains between two and four Vanguard index funds, keeping fees at a low 0.05 to 0.16 percent, plus the 0.6 percent administrative fee. Vanguard, not the donor, manages the allocation between funds.
Vanguard also allows donors to select from eight index funds to build a bundle of their own, allowing more control, with the list including a money-market fund, bond funds and broad stock funds covering the U.S. and foreign markets.
Schwab has the same 0.6 percent administrative fee and a variety of investing bundles from indexed to actively managed funds, and even a socially responsible fund option. Some of Schwab’s index fund fees are lower than Vanguard’s, while the fees are higher on actively managed funds.
Like Schwab, Fidelity offers managed funds as well as index funds. Its offerings divide into several pools: one focusing on single asset classes like large growth stocks or intermediate-term bonds; another devoted to “impact investing” like protecting the environment; and a “charitable legacy” pool that mimics an endowment by serving investors putting in at least $50,000 and preferring to make donations out of investment gains and keeping the fund going for a long time.
While some of Fidelity’s expense ratios are very low, others are quite high — exceeding 1 percent for a foreign large growth stock offering, for instance.
“The important thing for donors to understand is that total fees will be higher than they would be for mutual fund holdings,” Louton says.
The administrative fee could actually be seen as a convenience fee for the opportunity to get the tax deduction up front for money given to charity in the future, he says.
Fees matter, but if a donor-advised fund suits you, these new plans from the big fund firms will probably charge less than you’d pay for an account tailored by an advisor.
[See: These 7 Funds Make You Feel Good About Investing.]
Administrative fees and expense ratios are obviously also among factors to weigh, as are the investment options and minimums to start the fund, for additional contributions and dispersals to charities.
More from U.S. News
Why Investors Love Legacy Companies
The Top 10 Investment Portfolio for Millennials
The Best ETFs Retirees Can Buy
A Complete Guide to Investing in Donor-Advised Funds originally appeared on usnews.com
