Do you want your investments to support nonprofits that are meaningful to you, while you also receive a tax advantage?
If that sounds appealing, consider donor-advised funds, or DAFs. These are accounts that allow donors to make contributions to a qualified charity and receive an immediate tax deduction.
The funds in a DAF can be invested for tax-free growth.
Any investor can open a DAF; they are not limited to investors with ultra-high net worth.
“A donor-advised fund is like a poor man’s foundation,” says Matthew Benson, owner and certified financial planner at Sonmore Financial in Chandler, Arizona.
In addition to the tax benefits and the ability to gift assets to charities throughout the year, donors benefit from the fund’s reporting functions.
“You can give all of your charitable gifts to your donor-advised fund, then process the grants to the charities you support from there,” Benson explains.
This can be valuable at tax time, he says, as donors may not recall exactly which charities received what amounts.
“Most donor-advised funds will log all of your gifts and grants throughout the year, then be able to provide your year-end summary,” he says.
What Is a Donor-Advised Fund?
According to the IRS, a DAF is generally maintained and operated by a Section 501(c)(3) organization on behalf of the donor. A 501(c)(3) is a tax-exempt nonprofit organization headquartered in the U.S. that is limited to specific purposes such as charitable, educational, religious or scientific endeavors.
For example, brokerages including Schwab, Fidelity, Vanguard and others maintain charitable units, structured as 501(c)(3)s, specifically to hold and operate DAFs.
Frequently, donors contribute appreciated assets to DAFs, therefore avoiding the tax consequences they would face if they sold the securities themselves. Contributions to a DAF grow tax-free until the account owner donates to a qualified charity.
Spiros Vassilakos, CEO and private wealth advisor at Athenian Private Client Group in Tarpon Springs, Florida, says many of his clients use DAFs as a vehicle for charitable contributions.
“It can be an alternative to a charitable trust for those individuals who would like to see the monies go to the charity of their choice while they are alive,” he says.
How Donor-Advised Funds Work
Step 1: Make a Tax-Deductible Donation
The process of opening a DAF is essentially identical to opening any other investment account. Once the account is open, you can donate cash, stocks, bonds, cryptocurrency, life insurance and private company stock, among other assets.
Appreciated non-cash assets that you’ve owned for over a year are most advantageous for reducing your tax bill.
“Many DAFs have a minimum contribution; I have yet to run into one with a maximum contribution,” says Brenna Baucum, founder and financial planner at Collective Wealth Planning in Salem, Oregon.
“However, higher contribution amounts may come with increased levels of due diligence and maintenance,” she adds.
Baucum also notes that investors get to take an immediate tax deduction when they contribute to a DAF.
Step 2: Invest Your Contributions
Donor-advised funds typically offer equity or fixed-income options for asset allocation, including mutual funds and exchange-traded funds, or ETFs.
Larger donor-advised accounts may provide an investment advisor who can help manage the account. If you already work with a financial advisor, they can advise you on this account.
“We hold our clients’ funds with Schwab Charitable, and they have a large lineup of diversified pooled funds to invest in,” says Benson.
He explains that appreciated assets are sold once they arrive in the DAF, and then allocated to the pool of investments.
If the charity grants are to occur in the same year as the contribution, it may be wise to allocate to a conservative investment mix, says Benson. That way, the donor’s principal is less likely to decline significantly in value, resulting in less going to the charity than what was originally contributed.
Step 3: Give a Grant
There are typically no time restrictions on when you give a grant from your account.
A donor may give a grant to any 501(c)(3) that is classified as a public charity, says Benson. “This would exclude things like political groups and private foundations,” he says.
Some sponsors, including Fidelity, have a minimum grant requirement of $50 to maintain cost-effectiveness.
You can choose as many charities as you want to receive grants. “It’s essential that the recipient is a qualified U.S. charity recognized by the IRS,” says Jennifer Dazols, a certified financial planner at Modern Family Finance in San Francisco.
She adds that donors have the option to send individual grants anonymously for an extra level of privacy, if they prefer. That will also help the donor avoid being contacted by the charity for future grants.
Rebecca Conner, founder and lead planner at SeedSafe Financial in Austin, Texas, recommends that donors look at the IRS tax-exempt organization search tool to review which organizations meet the requirements to receive a grant.
“When reviewing DAF providers, it is important to know how and when you want to use the funds, so you can pick the best option for you,” she says.
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Donor-Advised Funds: A Tax-Savvy Way to Give to Charity originally appeared on usnews.com
Update 11/28/23: This story was previously published at an earlier date and has been updated with new information.
