Donor-advised funds can be a smart way to give back to the community while cutting taxes, but financial advisors who help clients set up these accounts should be well-versed in the details of how they work.
While there are many benefits of donor-advised funds, including having the flexibility to decide on a charity at a convenient time and having a place to put highly appreciated assets without triggering a tax bill, they’re not the best choice for everyone and should be handled with care.
What Is a Donor-Advised Fund?
A donor-advised fund is an account set up for the sole purpose of supporting 501(c)3 charities approved by the IRS, says Chloe Wohlforth, certified financial planner and managing director at Angeles Wealth Management, a firm that specializes in working with charities and philanthropic clients.
Donor-advised funds have been around since the 1990s, but they became popular following the 2017 tax-code changes, Wohlforth says. Those changes significantly increased the standard tax deduction for individuals and married couples, and made it harder for people to use charitable giving for tax deductions, says Nick Foulks, director of communications strategy and client engagement at Great Waters Financial.
To make their gifts count as tax deductions, people began bunching donations, that is, making several years’ worth of charitable gifts in one year to clear the standard deduction threshold. But doing so often leaves charities to face a feast-or-famine situation. Donor-advised funds allow clients to put enough cash or other assets into the fund to make the donations tax-deductible, but allow them to make gifts at a pace that suits them. “Donor-advised funds let you be a bit more strategic in how you want to control your taxation,” Foulks says.
Benefits of a Donor-Advised Fund
In addition to making it easier for clients to donate to charity, donor-advised funds have some benefits for advisors, too, says Stephen Dunbar, executive vice president at Equitable Advisors.
Because these funds can include many types of assets, including unusual and illiquid items such as art or antiques, which are difficult to give to charity, those items can be monetized to increase tax-deductible donations in a given year. That gives a client more flexibility on donations, but it also gives the advisor a sense of how all of the client’s assets fit into the financial plan.
Donor-advised funds allow advisors to create a closer relationship with the client and start conversations on estate planning or holistic planning, Dunbar says. That’s especially important for early-career advisors looking to deliver tangible value to their clients.
Early-career advisors and their early-career clients are “motivated by purpose and passion. It’s not just about building up my 401(k) and riding off into the sunset. They want their lives to matter. Donor-advised funds create an opportunity for the early-career advisor to really build a niche with their customer base. You start with charity, but then you make your way into other things. So that could be an interesting opportunity,” Dunbar says.
It’s also much cheaper to open a donor-advised fund now that many have low or no minimums. “Charity was thought of as a rich person’s game. Well, not anymore,” Dunbar says. “Use these as a chance to help people engage in their local communities and make a difference.”
Points to Keep in Mind When Opening a Donor-Advised Fund
Wohlforth says these funds are irrevocable, so once your client puts an asset in the fund, it is out of the estate. Watch fees, too, she says. Commercial custodians such as Schwab, Fidelity and Vanguard charge administrative, investment and sometimes maintenance fees to manage these funds. Administrative fees are often on a sliding scale, from 0.2% to 0.6% of the money in the fund, while investment and maintenance fees vary.
Another thing to remember is that, in addition to commercial custodians, some public charity community foundations run donor-advised funds as a way to pool money to support local nonprofits based in geographic areas.
Also, Dunbar says, when an advisor is setting up a fund, it’s critically important to know the “death triggers,” or what happens to the money upon a donor’s death. “Make sure you look at the fine print and make sure you understand the consequences,” he says.
For example, if a donor dies and there is still money in the fund, advisors must know where that money can go. “In some funds, that money can move to the general account of the sponsor, and they have full control over it at that point. So now you’ve lost the ability to direct (that part of) the estate planning,” Dunbar says.
When Not to Use a Donor-Advised Fund
Clients who donate small amounts of money each year shouldn’t bother with a donor-advised fund, Foulks says, as it’s not worth the administrative fees.
Wohlforth also notes that money that is part of a legally binding pledge shouldn’t go into a donor-advised fund because these are irrevocable gifts. Those pledges need to be done outside a donor-advised fund.
While donor-advised funds are often touted as tax vehicles, Dunbar says advisors and clients need to think of charity first, tax second. “Don’t let the tax tail wag the dog,” he says.
And remember that part of the appeal of giving to charity is the psychological and emotional return from helping others. “My issue with donor-advised funds is just turning it into a bank transaction, driven primarily by taxes and tax savings. And you sort of lose all this other psychic benefit and return you get from charity, which kind of guts the whole point of reaching back and helping others on some level,” Dunbar says.
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What Advisors Should Know About Donor-Advised Funds originally appeared on usnews.com