Are Donor-Advised Funds A Smart Tax Move?
Americans have been known for their generosity, donating billions of dollars to charitable causes each year.
In fact, it's estimated that Americans donated a staggering $558 billion to charities in the past year alone, reflecting a 1.9% increase in donations according to a USA report. Not only do Americans give money, but they also dedicate their time to good causes—last year, individuals donated a remarkable 4.1 billion hours to charitable efforts, which has immense value for the nonprofit sector.
If you're one of the many people who make charitable donations, whether in the form of cash, investments, or other assets, you might be unaware of the potential tax benefits that come with giving.
In fact, one of the best ways to manage your charitable giving while reducing your taxes is through a Donor-Advised Fund (DAF).
WHAT IS A DONOR-ADVISED FUND?
A Donor-Advised Fund is a charitable investment account that allows individuals to contribute money, stocks, or other assets to support their favorite charities.
These funds are set up through a public charity or a 501(c)(3) organization, which serves as the sponsoring organization of the DAF. Once you contribute, the money is placed in your donor-advised account, but the charity legally controls the assets.
However, as the donor, you retain advisory privileges, meaning you have control over how the money is invested and which charities receive the donations, as well as when those donations are made.
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WHY ARE DONOR-ADVISED FUNDS APPEALING?
One of the most appealing features of a DAF is that you don't have to immediately decide which charity will benefit from your donation.
Some individuals, like Warren Buffett, use donor-advised funds to let their contributions grow before donating, allowing the original donation to increase in value over time and providing a greater impact on future generations.
DONOR-ADVISED FUNDS VS PRIVATE FOUNDATIONS
Donor-advised funds are often compared to private foundations, but they come with several advantages. While private foundations require complex setups, including the hiring of attorneys and a board of directors, DAFs are much simpler to manage.
You don't need to worry about the administrative burdens of running a foundation. Although there are some fees associated with maintaining a donor-advised fund, they are typically much lower than the costs of running a private foundation.
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WHO SHOULD CONSIDER DONOR-ADVISED FUNDS?
DAFs are particularly well-suited for individuals who consistently donate to charity but are unable to take full advantage of the charitable deduction.
To deduct charitable donations from your taxes, you must be able to itemize your deductions. For many individuals, this isn’t an option. For instance, if you're a single filer and donate $1,000, but you can't itemize your taxes, only $300 of your donation may be deductible. The remaining $700 would not count toward your tax deduction.
If you're consistently donating large amounts, say $10,000 a year, but still aren’t able to itemize your taxes, a donor-advised fund could be a game-changer. It allows you to contribute to a fund and receive the tax benefit immediately while you plan for the distribution of your donations.
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HIGHLY APPRECIATED ASSETS
If you have real estate, stocks, or other assets that have significantly increased in value, a Donor-Advised Fund allows you to donate those appreciated assets to charity. This strategy helps you avoid paying capital gains tax on the growth while also receiving a charitable deduction.
Let’s say, you have a highly appreciated stock worth $200,000. By donating this to a DAF, you would receive a $200,000 charitable deduction. However, due to IRS rules, you're limited to how much of that you can deduct in one year.
For cash donations, the deduction limit is 60% of your adjusted gross income (AGI), and for appreciated securities or assets, the limit is 30%. If your income in a given year is $100,000, you can only deduct up to 60% of your donation ($60,000) in that year.
But here's the beauty—any amount that you can't deduct can be carried forward into future tax years, allowing you to continue to benefit from the deduction in the years to come.
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WHERE TO OPEN A DONOR-ADVISED FUND?
Several well-known financial institutions offer donor-advised funds, including Vanguard, Schwab, and Fidelity. These institutions have established charitable organizations that allow you to set up your DAF with them. For instance:
Fidelity Charitable Donor-Advised Fund: Requires a $5,000 minimum to set up.
Vanguard Charitable: Requires a $25,000 minimum.
Schwab Charitable: Also has a $5,000 minimum.
These platforms also allow you to make subsequent contributions, usually with a minimum of $50 per donation, which is convenient for ongoing charitable giving.
One thing to note is that there are annual costs associated with maintaining a donor-advised fund at these institutions. Generally, these costs run around 0.6% per year.
THE ROLE OF FINANCIAL ADVISORS
If you have a financial advisor, they can help manage your DAF for you, especially if you’ve made a large contribution.
For instance, if you reach a $50,000 balance, your financial advisor could work with Schwab or Fidelity to help manage the fund’s investments and ensure that your charitable giving is aligned with your financial goals.
ENGAGING YOUR FAMILY IN GIVING
Beyond the financial and tax benefits, donor-advised funds provide a unique opportunity to engage your family in charitable giving. Since the money sits in the DAF until you choose when and where to donate, you can make giving a family tradition. You could gather your family each year to discuss and choose charities to support, creating a lasting legacy of generosity and involvement.
RESEARCHING CHARITIES
Of course, whenever you're donating, it's crucial to research the charity to ensure your funds are being used effectively. Websites like Charity Navigator can help you assess how efficiently a charity uses donations and how much of the money goes toward its mission versus administrative costs.
By using a Donor-Advised Fund, you not only create a flexible way to give to charity, but you can also maximize your tax savings, create a legacy of giving, and ensure that your donations make the most impact for years to come.
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As always, have a great day, a better week, and I look forward to talking with you on the next blog post, podcast, YouTube video, or wherever we have the pleasure of connecting!
Written by Ryan Morrissey
Founder & CEO of Morrissey Wealth Management
Host of the Retire with Ryan Podcast