By Ginny Graef, Tax Senior Manager | Family, Executive & Entrepreneur Advisory Services Team
Have you heard the term Donor-Advised Fund (DAF)? Perhaps you have read about them or just heard the name in passing at a at a cocktail party. This may feel like a new term as it has become widely used of late, but is actually an older concept. This blog article talks about what a DAF is, the advantages and disadvantages, and why it might be a valuable charitable tool for you.
What are Donor-Advised Funds (DAFs)?
A DAF is a separately identified investment account maintained and operated by a qualified charitable organization (a.k.a. “sponsoring organization”). Some of the more popular sponsoring organizations that maintain DAFs are Schwab Charitable, Fidelity Charitable and Vanguard Charitable. When an individual makes a contribution to their DAF, it is considered a tax deductible charitable gift. The sponsoring organization then holds these funds in the individual’s account until the individual requests that the funds be distributed to their charity of choice. Good news: you get the full contribution as a charitable contribution on your income tax return. Even better news: If you donate long-term appreciated stock, you get the charitable donation at the fair market value of the stock and you avoid paying capital gains on any appreciation. A permanent tax savings on the gain!
When are Donor-Advised Funds Beneficial?
Donor-advised funds can be especially beneficial when an individual expects to have tax year with an unusually large amount of income (i.e., large bonus year, equity compensation year or sale of business). It is in these years that many want to make additional charitable contributions to offset the increase in taxable income. But, many individuals may not know what charity they want to give the money to or perhaps do not want to give the charity such a large amount in one tax year. In this scenario, the DAF would allow the individual to make a large charitable gift for which a current year tax deduction is allowed (and most beneficial), while giving them time to decide what charity they ultimately want the funds to go to. The funds stay in your donor-advised fund until you are ready to send the funds to your charity of choice. While there may be some limits on minimum payments out each year or how long the funds can be held, these restrictions rarely pose problems for potential donors.
It should be noted that once an individual contributes funds to the donor-advised fund, technically, they are no longer the legal owner of the money. The sponsoring organization is now the legal owner and has ultimate authority as to how the funds are distributed. The individual can only “advise” and make recommendations to the sponsoring organization as to where they want the funds in their DAF to go. However, in almost all cases the recommendations of the individual are respected. Obvious reasons for which the sponsoring organization might deny an individual requests would be if the monies were to be sent to a non 501(c)(3) organization or perhaps a foreign charity.
Five Tax Advantages of Donor-Advised Funds
1. Many donor-advised funds accept non-cash donations or hard to value assets that ordinary operating charities will not or cannot accept.
For instance, some DAFs will accept artwork, Bitcoin, real estate and certain complex assets, such as privately held C-Corp and S-Corp shares. Many smaller charities are not equipped to handle such donations but with a donor-advised fund, you can still donate your hard to value asset and support your small charity.
2. Anonymously support charitable organizations, as you can name your DAF anything you would like.
When a donation is made from your DAF, the charity will publicly recognize the donation as coming from the name of your DAF rather than your individual name. Conversely, you can choose to name your DAF in a way that acknowledges your entire family by naming your fund something like “The Smith Family Charitable Fund” rather than having only one individual named.
3. Money in a DAF grows tax-free and any appreciation in the fund is added to your original contribution, thus increasing the amount that ultimately can be donated to charities of your choosing.
4. DAFs are extremely easy to administer and offer simplified record keeping for tax purposes.
DAF owners do not have any additional tax filings and the funds are invested and maintained by the sponsoring organization. From a record keeping standpoint, when you make a donation to your DAF, that is the only charitable receipt to keep track of. Without the use of a DAF, individuals must keep a receipt from every single organization where a donation was made. And if you tend to make smaller donations to a lot of charities, recordkeeping can become quite time-consuming.
5. Many DAFs will allow you to open accounts with only minimal funding requirements, generally as low as $5,000.
Before the existence of DAFs, private foundations were the only similar charitable vehicle, and after costs of administration, legal and accounting fees, it really only made economic sense for the very wealthy to fund such a vehicle. However, with the creation of the DAF, tax savings strategies that were only available to the few, are now an option for millions of taxpayers. In fact DAFs have become so widely available, in 2017 there were over 460,000 DAFs in existence with more than $29 billion in assets.
Disadvantages to Donor-Advised Funds
There are some disadvantages to DAFs that should be mentioned as well.
1. Once you contribute the money to your DAF, technically you no longer have legal control of the assets and can only advise the sponsoring organization as to what charity you would like your funds to go to.
2. Investment options for assets in a donor-advised fund are often somewhat limited.
3. There are management fees charged for maintaining and investing the assets.
Before choosing a sponsoring organization, you should inquire as to the various fees charged.
Donor-Advised Fund Types: Community Foundations
When deciding what DAF is right for you, you will want to also explore the idea of using a sponsoring organization called a “community foundation”. Community foundations operate very much like a Schwab, Fidelity or Vanguard Charitable fund, but their mission is to also improve the quality of life in a specific geographic region. Typically a community foundation will invest your donated assets and part of the management fees charged are earmarked for a general fund. Community foundations also offer added benefits that larger broker managed DAFs do not, such as helping donors identify or clarify their charitable goals, providing donor engagement opportunities, and working with the larger family group to help achieve charitable objectives. The board of the community foundation, along with input from individual account owners, then uses those general fund assets to make grants to local community organizations. This is a wonderful option if you feel strongly about helping your local community prosper. The Community Foundation for a Greater Richmond is such an organization. It was founded in 1968 and has given over $1 billion to thousands of nonprofits in the area. In full disclosure, Keiter and many of its clients routinely work with the Community Foundation of greater Richmond and have appreciated their partnership over the years.
Lastly, it should be noted that with the passage of the Tax Cuts and Jobs Act of 2017, DAFs and community foundations have become an even more powerful planning strategy. I encourage you to discuss your particular tax situation with your CPA or investment advisor to see if a DAF is right for you, especially in light of the Tax Cuts and Jobs Act of 2017 changes.
Questions about Donor-Advised Funds? We can help. Contact your Keiter representative or our Family, Executive & Entrepreneurial Advisory Services team. | Email | 804.747.0000
Resources for exploring the world of Donor-Advised Funds:
- Community Foundation for a Greater Richmond
- Fidelity Charitable
- Schwab Charitable
- Vanguard Charitable
Additional Family, Executive & Entrepreneurial Advisory Services Resources:
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.