Donor-Advised Funds (DAFs) can bring a lot of simplicity to the complex world of charitable giving. Though many investors would like to incorporate charitable giving into their financial planning, many approach it piecemeal, with a resulting process that is overly time consuming and complex.
A DAF allows an investor to make contributions to a single fund and retain advisory privileges over both investments and distributions from the fund.
Donor-Advised Fund Overview
A DAF basically serves as a middleman for the donor’s charitable giving strategy. The DAF is a sponsoring charity set up as a 501(c)(3) organization.
The donor makes gifts to the DAF and generally receives a current tax deduction for the contribution. The DAF invests the funds per the donor’s wishes and makes distributions to operating 501(c)(3) charities per the donor’s instructions.
By donating appreciated securities, the donor can take a tax deduction for the full value without having to pay gains tax on the appreciation. When the DAF sells the appreciated investments, it incurs no tax as a charitable organization.
The donor can instruct the DAF to make contributions on their behalf to any qualified 501(c)(3) organization. Contributions to other organizations are not allowed, putting a minor limitation on the use of the funds. For example, the DAF could not be used to contribute to political organizations.
Contribution Limits of Donor-Advised Funds
The IRS limits deductions for contributions to a DAF to 30 percent of adjusted gross income (AGI) for contributions of non-cash assets held for over one year and 60 percent of AGI for cash contributions. Excess contributions can be carried over for up to five years.
Though the tax incentives of the CARES Act for charitable giving allow for deduction of cash contribution up to 100 percent of AGI for donations to operating charities in 2021, this does not apply to contributions to DAFs or to private foundations.
Donors may benefit from stacking contributions when their itemized deductions fall below the level of the standard deduction.
By stacking contributions in one year, they may be able to itemize and take advantage of the charitable deduction, then claim the standard the following year, presuming no carryforward. This strategy can result in a greater total deduction across the two-year period.
DAF contributions may be subject to heightened IRS scrutiny. There has been some history of inappropriate and shady use of these vehicles. You cannot use a DAF to return income back to yourself or to make contributions where you receive something in return, such as event tickets.
There are a number of reputable organizations that administer DAFs. Donors should do their homework to make sure the fund is above board. It should not be difficult to find a good fit; there are many great options.
Naturally there are costs involved, and these should be examined and considered carefully. The benefits are significant, but it still behooves the donor to minimize unnecessary costs.
Planning Considerations for Donor-Advised Funds
Gifting appreciated assets provides additional tax benefits to the donor, as noted above. You bypass the tax on the capital gains while getting a full fair market value for your contribution.
By gifting assets now, you remove future growth from your estate. This can help lower future estate taxes and is an important planning consideration.
DAFs can greatly simplify a donor’s gifting strategy. A single donation or series of donations is made to a single DAF, reducing the amount of administration and record-keeping. There is no additional reporting when distributions are made to the qualified charities.
DAFs can likewise simplify estate administration. Rather than making multiple charitable bequests, a donor can make a single bequest to their DAF and separately provide the DAF with distribution instructions.
Some donors use DAF deductions as an offset to taxes they would have due to retirement plan distributions or from Roth IRA conversions. Tax qualified assets may also be a good choice for funding a DAF upon death, leaving assets with lower tax burdens to your heirs.
The Bottom Line
Donors frequently struggle with the conflict between making charitable donations and giving up control of their assets. Contributions to a DAF no longer belong to the donor or are under their direct control, but donors can generally retain advisory privileges over investment and distribution of the assets.
Perhaps the greatest benefit of using DAFs is its simplicity. You can make contributions of assets now and take advantage of the tax deduction while postponing the complex decision of which charities to include and to what extent. You retain advisory privileges over investments and distributions.
A DAF is not for everyone. In many cases, a simple gift of an asset or multiple assets, or a bequest, is sufficient. For those who have had the good fortune to have accumulated sufficient assets to make a number of gifts, a DAF may be a great tool to help manage implementing their gifting strategy.