Many of us have causes that we care about and charities that we want to support. And it’s been found that making charitable donations, be they donation of your money or your time, makes us happier! Of course, being generous is its own reward, but there are financial benefits to making charitable donations and not just for the charity. Let’s take a look at donor-advised funds.
What is a Donor-Advised Fund?
A Donor advised fund, or DAF, is like a charitable investment account designated for the purpose of granting to churches and charities that you care about.
It is a flexible, tax-advantaged way to make charitable donations. A third-party custodian holds the account, and the assets inside it can be used to support any 501(c)(3) IRS-qualified charity. You can choose to donate to a single cause or as many as you desire, even international charities, as long as they fit the IRS criteria.
Besides cash gifts, you can donate a variety of assets to a donor-advised fund, including:
- Publicly traded stocks
- Private company C-corp stocks
- Private company S-corp stocks
- Restricted stock
- Private equity
- LLC and Limited Partnership interests
- Hedge fund interests
- Mutual fund shares
- Pre-IPO shares
- Bonds
- Life insurance
- Cryptocurrencies
- Retirement assets
- Oil and gas royalty interests
In 2020, nearly two thirds of contributions were in the form of non-cash assets.
Contributions made to a donor-advised fund are an irrevocable commitment to charity; once given, they cannot be withdrawn.
The Benefits of a Donor-Advised Fund
Donor-advised funds have gained in popularity in recent years because they allow a donor to have a high level of control over their donations while making the administration of charitable giving easier. Donor-advised funds also lower the entry bar for charitable giving; you can open one for as little as $5,000. It can also buy a donor time if he or she hasn’t yet decided what charity to donate to or if they need time to save up in order to make a more significant donation.
High earners can use a donor-advised fund to reduce tax liability. Unlike private foundations, a donor-advised fund can offer a federal income tax deduction of up to 50% of adjusted gross income for cash contributions and up to 30% of adjusted gross income for appreciated securities donated.
When a donor contributes certain assets into a donor-advised fund, they can avoid paying capital gains taxes and receive a fair-market value tax deduction.
Example of Donor-Advised Fund Strategy
Let’s say you buy a stock for $50 per share, and it appreciates to $100 per share. You decide to sell that stock and donate the proceeds. You will pay a 15% capital gains tax, for example. Then you net $85, and that’s your donation.
But if you have a donor-advised fund, you can contribute the share of stock to the fund, which means it’s not a taxable event for you. You get to take an income tax deduction on the fair market value of the stock, so the entire $100!
A donor-advised fund allows your contributions to grow tax-free. There are no rules regarding when you have to release the assets inside the fund to a charity. You can leave the assets to grow for five years or 20 years; it’s up to you. But, you get the deduction on your contribution for that tax year even if you don’t donate to a charity that year.
While donor-advised funds have many advantages, some factors to be aware of include but are not limited to possible account balance minimums, limits on grant allocations, management fees and the potential that future tax laws may change and impact the tax treatment and benefits of donor-advised funds.
Think Outside the Box
Our ultimate goal is to keep the most dollars we can in our pockets to better live the life we love. To best do that, sometimes it pays, literally, to think outside the box, to look for strategies that can help.
Bunching, or grouping, is one way to maximize the benefits of a donor-advised fund. Bunching works like this:
- You donate $400 a month into your donor-advised fund, $4,800 a year.
- It’s a year where you’re teetering between taking the standard deduction when doing your taxes or itemizing deductions.
- You can choose to dip into your savings to increase the amount of your contribution to $9,600, two years of contributions.
- You’ve grouped two years into one for the current tax year to maximize your itemized deductions.
- The following year, you don’t contribute, so you take the standard deduction rather than itemizing.
Another scenario where using a DAF might make sense is in a year when you have unusually high income, say from a bonus or from selling an asset with a large capital gain.
Or instead of selling the asset with a potentially large capital gain where you would owe taxes, you could potentially donate the asset, or a part of the asset to your DAF, receive the immediate income tax deduction and use the proceeds once liquidated inside the DAF to grant to charity.
Family Legacy
DAFs can be a good tool for involving the whole family in giving decisions. Children can be named as beneficiaries on the fund, and you can view your giving trends over time. Giving financially is one important way that we can be intentional about creating a family legacy of generosity and supporting the causes we care about most.
It’s these kinds of “think outside the box” micro-actions you need to put into play if you want to live the life you love!
Check out our recent podcast on DAFs.
