Donor-advised funds (DAFs) have gained popularity as versatile charitable giving accounts. DAFs allow donors (account holders) to receive immediate tax deductions while strategically directing payments to charitable organizations over time. In this article, we’ll delve into the fundamentals of DAFs, their operational aspects, potential benefits, strategic utilization, and considerations to help you determine if they align with your philanthropic goals.
Understanding the Basics of a Donor-Advised Fund
To initiate a donor-advised fund, a donor establishes an account with a sponsoring organization, provides an initial gift (contribution), and later decides on the disbursement of funds to charitable recipients. Distinct from private foundations, DAFs offer ease of establishment, enhanced privacy, and the absence of a mandatory 5% annual asset distribution requirement.
How a Donor-Advised Fund Works
Selecting a sponsoring organization is the initial step in setting up a DAF, with most major financial institutions capable of facilitating this. While no legally mandated minimum funding requirements exist, each institution may impose its own criteria. DAFs accommodate a broad spectrum of assets, from cash and real estate to investments and life insurance. The flexibility in contribution types allows donors to align their giving strategy with both charitable goals and personal preferences.
One notable advantage of DAFs is the ability to claim tax deductions from contributions. Directly contributing appreciated assets further enables donors to bypass capital gains taxes that would otherwise be incurred through asset sales. Eliminating the capital gains tax—15% or 20%, depending on the donor’s income level—can increase the amount available for charities by up to 20%. You may claim a fair market value charitable deduction for long-term gain assets. While short-term gain assets (held for less than 12 months), the deduction’s value is limited to the cost basis.
Benefits of Using a Donor-Advised Fund
The primary allure of DAFs lies in the associated tax breaks. Depending on the type of contribution, deductions can range up to 60% of the donor’s adjusted gross income (AGI) for cash contributions and up to 30% of AGI for donations of securities or other assets. Highly appreciated assets present an opportunity for substantial tax savings by entirely avoiding capital gains taxes.
In addition to tax advantages, DAFs streamline charitable giving by centralizing record-keeping, making it more manageable and efficient. If privacy is a priority, DAFs offer a distinct advantage over private foundations, as they are not required to disclose donor information to grant recipients.
DAFs also provide an avenue for establishing a legacy of family giving. Involving family members in the decision-making process fosters collaboration in selecting organizations to receive gifts annually, reinforcing a sense of shared philanthropy. Plus, if you know you want to take advantage of the tax benefits associated with charitable giving now, but want to talk to family members or do more research on which organizations to donate to before making a grant, DAFs offer this level of flexibility. The tax deduction is taken the year in which the contribution is made to the DAF. Then, you can donate or grant the funds to organizations whenever you so choose. This gives you the wiggle room to chat with loved ones, look into different charities, or clarify your philanthropic goals and values.
Strategies for Leveraging a Donor-Advised Fund
You can use your Donor-Advised Fund to align your philanthropic and financial goals with your values. Before making a grant from your DAF, you can:
- Research whether or not an organization is efficiently using its donations. By supporting efficient organizations, you maximize the impact of your gift.
- Look into different organizations that align with the causes you care about. DAF contributions can be directed toward various initiatives, such as disaster relief, impact investing, or even invested in impact investing funds.
- Determine whether you want to concentrate your donations on one organization or diversify by investing in several causes and campaigns. You may choose to fund your DAF but hold a portion of your investments to ultimately donate when a timely need arises. For example, if an organization you care about routinely needs donations after a natural disaster, you could earmark a portion of your DAF funds for donating when it’s needed most and will directly impact the communities you’re passionate about supporting.
- Decide how you want your DAF to integrate into your estate plan. A DAF can be integrated into your estate plan, creating a lasting family legacy of giving for future generations. When establishing a DAF, you can appoint successor account holders who will have the authority to recommend grants and continue the philanthropic legacy after your passing. This could include children or grandchildren in your legacy and help build a family culture of giving.
Potential Drawbacks and Considerations
Despite the benefits of Donor-Advised Funds, there are a few considerations to keep in mind before jumping in feet first. Administrative expenses associated with DAF operation and compliance with IRS rules can make them more costly to maintain than direct gifts to charity. However, not all sponsoring organizations have high administrative expenses – so make sure to do your research! Additionally, there are restrictions on gift recipients, limiting them to IRS-approved private foundations or public charities and excluding individuals or political parties.
Is a DAF Right For You?
If philanthropy is integral to your financial plan, incorporating a Donor-Advised Fund could offer additional benefits for you and the charities you support. Privacy, tax deductions, and the potential for tax-free investment growth make DAFs a valuable tool in strategic giving, enabling a more substantial philanthropic impact than direct gifts alone. Consider your philanthropic goals, values, and the long-term impact you wish to create when determining if a DAF aligns with your charitable objectives.