Mulling over whether you should give to your favorite charity, nonprofit, or cause? Now’s the time to pull the trigger if you want to claim a charitable tax deduction this year. But let’s say that you can’t decide on the right recipients for your money. It’s a daunting choice. This is where donor-advised funds, or DAFs, come in to save the day.
What Is a Donor-Advised Fund, and How Does It Work?
You place your donation — cash or other assets — in a DAF and claim an immediate tax deduction for that amount. And you don’t have to be rich to open an account.
But what’s really cool about donor-advised funds is that your money is invested tax-free the way you want while you figure out which charity should receive your money.
The more your money grows in value, the more you can give when you’re ready.
The folks managing DAFs vet each charity, so they can give you the best advice and data to guide your final decision. The fund also cuts the check to the charity.
Brokerage firms Fidelity and Schwab only require a minimum of $5,000 to start. Vanguard and the National Philanthropic Trust want $25,000. Whichever you choose, you can go online to open a DAF.
In 1991, Fidelity Charitable rolled out what some see as the first modern-day DAF. However, the concept has been around since the Great Depression. Fidelity Charitable and rival Schwab Charitable allow you to donate as little as $500 each year after your initial $5,000 donation.
How Are Donations Invested in a Donor-Advised Fund?
In 2020, U.S. charities took in $34.67 billion in grants from donor-advised funds, according to the National Philanthropic Trust's 2021 annual report. On top of that, the total amount of charitable assets held in DAFs, which are counted as charities themselves, reached $121 billion.
Investing in a donor-advised fund is akin to investing in an individual retirement account (IRA). Like donor-advised funds, IRAs are a great way to get a tax deduction. You can place your money in stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
Or if you don’t like risk, just stick your donation in a money-market account, which is like a savings account with service charges.
Speaking of risk, I recommend you invest your donations conservatively. Keep half of it out of stocks.
What Non-Cash Donations Can You Make?
Unlike many other charities, donor-advised funds accept many kinds of non-cash donations. If you have an IRA loaded with mutual funds and ETFs, you can donate your IRA.
Own real estate or a life insurance policy? You can donate those assets, too. And in some cases, DAFs will even accept bitcoin.
Just remember that there are limits on what you can donate to secure a tax deduction. It ranges from 30 to 60 percent of your adjusted gross income and varies based on the type of asset you contribute.
The Drawbacks of Donor-Advised Funds
As practical and promising as they sound, DAFs do have a few drawbacks. First, you can never get your money back for any reason.
Second, you have to pay a bit in recurring fees as your money is invested. Fidelity, Schwab, and Vanguard each charge an administration fee of about 0.6 percent. This comes out to $60 a year on a $10,000 investment.
You also have to pay fees to the mutual funds or ETFs holding your donations, as well as trading commissions, which are levied every time you buy or sell within your DAF. Over time, fees can eat away at your overall donation.
Another concern? Your donation may never actually make it to a charity. By law, it can sit in perpetuity in the DAF. You can pass it on to your heirs who may never touch it. And while your money grows (or not), Fidelity and Schwab are making money off of you. That’s money, critics contend, that could be better spent on the charities.
The Bottom Line
To sum up, a DAF’s benefits outweigh its drawbacks. If you do your homework and mind your fees, you’ll end up selecting the best investments and minimizing the fees that you need to pay. That said, donor-advised funds offer the budding philanthropist a simple and efficient way to get tax breaks while giving back.