Donor Advised Funds: Don’t be daft, use a DAF
The connection between generosity and happiness is strong, especially when there is a personal connection to the recipient or the opportunity to see the specific impact of the gift. According to one study, the impact of giving to charity on personal happiness is roughly the same as the happiness from doubling your income! The positive impact of giving persists when controlling for the giver’s financial situation, and is not dependent upon the absolute size of the gift (the widow's mite, Luke 21:1-4). Giving your time in addition to your money can be even more rewarding, because of the greater connection it creates between the giver and the receiver.
Donor Advised Funds (DAFs) are a simple but powerful tool to facilitate charitable donations, manage tax liabilities, and create a culture or legacy of charitable giving. No one donates to charity just to save on their taxes (the math doesn’t work like that!), and the many personal benefits of charitable giving are not necessarily correlated with the size of your gift or the resultant tax deduction. However, if you are already inclined to give (and I recommend it), DAFs are one of the more effective arrows in the quiver of a financial planner.
What is a Donor Advised Fund
A Donor Advised Fund allows someone to donate assets to “charity” today, receive the tax deduction now, and then distribute the funds to a specific charitable organization at a later date. The DAF functions as a conduit, separating the timing of the contribution and the tax deduction, from the ultimate donation to the charity itself. Assets within the DAF can grow tax-free, but the deductible amount is set as of the date that the funds go into the DAF. Once money goes into the DAF, it can only be granted to a public charity (you can’t take it back out again), but you can redirect the grants to different charitable organizations.
The most common use of a DAF is to “front load” charitable donations, either because of a windfall or high-income year, or to concentrate multiple years of charitable donations to exceed the standard deduction and get a greater tax benefit. However, this simple tool has many uses for those who are charitably inclined beyond basic front loading.
Strategies for using DAFs:
Frontloading Donations
The Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction amounts. While this simplified many folk’s tax returns, it also meant that many fewer folks would be able to claim a charitable deduction, because they received no benefit from itemizing. For folks who regularly donate to charities but don’t exceed the standard deduction normally, the DAF allows you to combine two or more years of charitable donations into a single year. If cash flow is a concern or you want to spread out the contributions, consider making donations for year one in January, and for year two in December. All that matters for tax purposes is that the donations are made in the same tax year. As a simple example, one might alternate years, double donating to a DAF in year A and itemizing deductions on taxes that year, and then not contributing to their DAF while claiming the standard deduction in year B, all the while actually distributing money to their favorite charities from the DAF throughout both years.
Offsetting High-Income Years
If you experience variability in your income from year to year, or you have a taxable windfall, the DAF allows you to utilize the charitable deduction to offset income in that higher tax bracket. The higher your tax bracket, the more the charitable deduction is worth (e.g. offsetting income at the 35% tax bracket has more value than offsetting it at the 22% bracket). If large Roth conversions are part of your strategy, contributions to a DAF can effectively offset the increased topline income the Roth conversion produces (but beware of contribution limits).
Donating Appreciated Assets More Easily
One of the biggest benefits of any charitable giving strategy is the ability to donate appreciated assets and “neutralize” any long-term capital gains. This is not unique to DAFs, but it can make it easier. The DAF will facilitate the sale of those appreciated securities (stocks, ETFs, mutual funds, even real estate ) within the charitable organization. The donor can deduct the full fair market value (up to 30% of their AGI in a given year for long-term assets) while avoiding the capital gains tax they would have paid had they sold the asset and donated the cash. For this reason, it rarely makes sense to give cash to charities if you have appreciated assets in a taxable account. Many charitable organizations will accept donations of stock and other assets directly, but the DAF streamlines the process for everyone.
A Simpler (Often Superior) Alternative to Private Foundations
The ability to separate the timing of charitable donations for tax purposes from the actual distribution to charitable organizations is not unique to DAFs. Establishing a private foundation can do the same thing, however, they are more costly to establish and operate. For this reason, DAFs have become known as the “poor man's foundation,” but in many instances, DAFs are superior, even for very high net-worth donors and large donations. For one, the tax deduction for appreciated assets given to a private foundation is limited to 20% of AGI, compared to 30% for public charities, which includes DAFs. Private foundations are also more expensive to operate, may face a 2% excise tax on any investment income, and must distribute 5% of the assets annually. DAFs have no such requirements. Therefore, private foundations are only advisable in situations where the donor wishes to make grants to individuals (e.g. scholarships), wants to retain greater control over the investments or assets, or if there is a desire to compensate people (including family members) for their involvement in managing the foundation.
Making Anonymous or “In Memoriam” Donations
The ultimate distribution comes from the charitable organization that sponsors the DAF, which does not have to disclose the source of the original funds. The name of the donor need not be disclosed unless they so choose. Many donors choose to name their DAF after their family (e.g. “The Smith Family Charitable Fund”), but it can also be named for someone else (e.g. “In Memoriam of Mr. Smith). DAFs can accept donations from multiple sources and could be listed for “gifts in lieu of flowers,” but beware of minimum initial and subsequent contribution limits.
Involving Children in Charitable giving
Families can give their children the opportunity to research and direct some amount of the family’s giving each year to an organization of their choice. Involving children and teenagers in these discussions can open their eyes to the needs of others and can be a formative experience that may just lead to lifelong habits or a calling.
As an Employee Benefit or to Augment Workplace Culture
Employers can encourage employees to create their own DAFs by offering to match gifts up to a certain amount into the employee’s DAF. The employer will retain the tax benefit for amounts that the employer contributes to the employee’s DAF, but the employee can direct the grants toward the charities of their choice.
A Legacy-Giving Vehicle
A DAF can be a charitable beneficiary under a decedent's will, revocable living trust, or investment account. These assets would not be subject to the 40% estate tax and can provide heirs with greater flexibility or the opportunity to decide which charities will receive the money. A DAF can also be named as the ultimate beneficiary of a charitable remainder trust if the grantor doesn't yet know which charity to name or he/she wants to have the flexibility to change the beneficiary, especially when the ultimate bequest may be years away.
To Monitor a Charity’s Fiscal Responsibility Over Time
For more significant donations, especially to smaller or newer charitable organizations, a donor may be wary of giving a single large donation. Perhaps the charity may not be able to put such a large amount to work, or the donor may want to monitor how the organization manages its operations over time before granting additional amounts. If the charity fails to operate responsibly or shows that it cannot put the donation to effective or timely use, the donor can redirect DAF funds elsewhere but still have the initial tax deduction and tax-free growth.
Where can I set up a DAF?
The largest DAF providers include Vanguard, Fidelity, Schwab, and National Philanthropic Trust (NPT). Each has different requirements for minimum and subsequent contributions, fees, investment, and management options. In addition to the large national DAF providers, many local community foundations and faith-based institutions also offer DAFs. These institutions may have fewer investment choices (or no choice at all) and they may be less able to handle more complex assets that can be contributed to DAFs (such as real estate, partnership interests, or other less liquid assets). On the other hand, a community-based DAF provider may be more connected to local charities and familiar with their needs and impact.
Major DAF Providers Comparison from Kiteces.com
