Being philanthropic can mean you donate your time, expertise and/or financial resources to support a charitable organization. When donating financial resources, there are ways to give that maximize the benefit of the gift. Did you write a check? If so, where did that cash come from? Did it require you to withdraw from a retirement account, or realize any capital gains to create this cash? If you have a taxable investment account, then using a donor-advised fund is a more efficient way to give.
What is a donor-advised fund?
A donor-advised fund (DAF) acts like your own mini-charitable foundation. DAFs have been around since the early 20th century, but more recently have become the fastest growing method of giving in the United States. Grants to qualified charities in 2015 alone from donor-advised funds totaled $14.52 billion. You can donate assets to a DAF and receive the tax benefit that year, while having the flexibility to distribute the funds in increments, and over whatever period you’d like. Unlike private foundations, DAFs don’t have legally required annual distributions.
What can be put in a donor-advised fund?
- Publicly traded securities including stocks, bonds and mutual fund shares
- Restricted and controlled stock * Privately held stock
- Real estate
- Proceeds from life insurance or from a full-paid policy
- Private foundation grants or terminations
- Named beneficiary of charitable remainder trust
- Named beneficiary of an IRA, 401(k) or other retirement account
- Tangible personal property
Most commonly, families donate appreciated securities such as stocks and mutual fund shares from a taxable investment account to a DAF.
Note: Qualified charitable distributions (QCDs) from retirement accounts are not an eligible source for contributions to a DAF.
How do they work?
A DAF fund allows you to transfer assets to receive the tax break now, diversify those assets and distribute them to charitable organizations over whatever time period you’d like.
The first step is to determine the amount you want to give at this particular time. Second, identify which financial resources you want to transfer to the DAF. Since you receive a tax deduction for the donation and won’t owe capital gains tax upon its transfer, first try to find positions that have large capital gains. This may be an individual stock or mutual fund that’s become too large a part of your portfolio, but you’ve held onto to it to avoid paying the capital gains tax.
For convenience, you’ll want to open the donor-advised fund at the same custodian where you hold your taxable assets:
- Charles Schwab: https://www.schwabcharitable.org/
- Fidelity Investments: https://www.fidelitycharitable.org/
These custodians have a $5,000 minimum donation required to open a DAF.
Once the securities are transferred to your DAF, they’re then sold and reinvested per the allocation instructions you provided on the paperwork. In many cases, families keep between 1 to 5 years of planned giving in cash and reinvest the rest in the allocation.
Once this is done, you can start selecting charitable organizations you’d like to give the money to and request the distribution(s) from the custodian of your DAF.
What are the tax benefits?
The fair market value of the asset(s) transferred on the day of the donation is used to calculate your tax deduction. This amount is then included on your tax return on Schedule A: Itemized Deductions under Charitable Gifts. The maximum amount you can deduct in a single year for charitable gifts for DAF’s is 30% of your adjusted gross income (AGI). If part of your gift is not deductible in the current year due to these limits, you can carry forward the remaining charitable gift deduction for 5 years.
Note: You can deduct gifts of cash to a DAF up to 50% of your AGI in a single year.
What are some common reasons people open DAFs?
- Appreciated stock: Let’s say you have individual stocks or mutual fund shares that have large gains. Instead of selling those positions and having to realize a capital gain and pay tax, you can instead donate all or part of it to a DAF. This concentrated position is then sold and diversified once in the DAF. In this case, the DAF would help rebalance your portfolio while providing a tax benefit!
- Selected charity doesn’t accept direct stock gifts: Unfortunately, many organizations aren’t set up to accept direct transfers of stock. They’d have to have a relationship with a broker to receive the securities to then sell and receive the proceeds. DAFs circumvent this problem as distributions come in the form of a check the organization can accept.
- Unexpected spike in your income: Consider a year in which your income increased to a much higher level than usual due to a bonus, payout of deferred compensation or the vesting of restricted stock. In these events, your tax rate is also likely to spike on those additional dollars received. In those years, moving part or all of that income increase into a DAF can dramatically reduce your taxes and provide assets to distribute to charity throughout the rest of your life.
- Drop in future income due to retirement: Presumably, you’ll be in a lower tax bracket in retirement, making deductions less valuable. Instead of waiting until retirement, you could instead fund several years of anticipated annual gifting into the DAF in your last full year(s) of employment to receive the biggest tax deduction. The DAF can then be distributed to charities of your choice throughout retirement.
- Include children/family members in the giving process: With donor-advised funds, you can delegate the decision about where to give your money. Many families use DAFs include their children in the giving process by allowing them to participate in the selection of the charity.
- DAF as a Traditional IRA (pre-tax) retirement account beneficiary: Qualified charities listed as IRA beneficiaries wouldn’t owe taxes on distributions upon your passing (so they receive 100% of the benefit), compared to normal beneficiaries owing income tax on distributions. Like listing a charity as a beneficiary, you can name a DAF as a beneficiary as well. This allows designated family members to distribute the proceeds from your retirement account to charitable organizations. Many people don’t feel comfortable naming one or a small list of charities as their IRA beneficiaries and appreciate the flexibility a DAF provides. They also like that it gives their children/family members an opportunity to work together to determine how best to give away the money (of course, you can share your wishes with them as well).
- Received a large cash windfall: If you received a large cash windfall, such as from an inheritance, sale of a home, sale of a business or simply have just accumulated a lot of cash savings, you could contribute cash to the DAF. This gives you a deduction of up to 50% of your AGI in a single year, which could lead to a lot of tax savings. More importantly, the DAF would allow you more time to decide how best to distribute the funds versus donating it all to one organization in a single year. Also, donating cash instead of securities is a good option to consider if you don’t have large capital gains in a taxable investment account.
We recommend you speak with your advisor to discuss whether a donor-advised fund makes the most sense considering your specific circumstances.
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Geoff has always enjoyed talking with people about finance, learning about their investments, financial strategy, and business sense. His interest only deepened with time, and what began as a hobby has now become a life-long passion, with an unparalleled passion for continuing education that makes him an expert in many subjects from traditional taxes and investments to business succession planning and executive compensation negotiations.
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