Being in the position to be able to use your financial resources to give charitably is a beautiful thing. Once you reach the point in your financial journey when you are considering how charitable giving fits into your financial plan, you have many options. You must determine your goal in your charitable giving, create a plan, and adjust to changes. Utilizing a donor-advised fund (DAF) is a comprehensive strategy to maximize your decision on how, when, and where to give while keeping things simple and efficient for you.
When it comes to giving, there are an overwhelming amount of strategies to consider. In addition to donor-advised funds, our blog post, ‘Boost Your Tax-Efficiency with a Powerful Strategic Giving Plan’ reviews tax credits for a more local impact and giving through trust account strategies. Donor-advised funds have an advantage over the other options as they are a simple, tax-efficient vehicle to give to a broad array of charities. DAFs are the catch-all of charitable giving; you get all the benefits without the complexity.
A donor advised fund is an account dedicated to charitable giving. As the donor, you have control of where and when the funds are given to charity. A significant financial planning advantage to utilizing a donor-advised fund is tax centric. Once you move funds to your donor-advised fund, you may claim a tax deduction immediately if you are itemizing.
Is this right for me?
The first step is to determine your charitable giving goal. The minimum amount to start a donor-advised fund varies based on where you are opening your account. The minimum range fluctuates between $5,000 and $25,000. You may opt to contribute cash to your donor-advised fund, securities, illiquid assets such as real estate, or even life insurance. Once you determine the amount you would like to start the account with, the gift to the donor-advised fund is irrevocable. There is no reversing the decision once the money is the account. You can also add to the account over time.
Not everything is treated equally in terms of tax benefits in a donor-advised fund. If you contribute cash, you may deduct the amount of the donation limited to 60% of your adjusted gross income (AGI.) Suppose you contribute securities such as mutual funds, stocks, or ETFs. In that case, the deduction depends on how long you’ve owned the security.
- If less than one year, you may deduct the fair market value limited to 30% of your AGI.
- If more than one year, you may deduct the lower of either the cost basis or the current fair market value limited to 50% of your AGI.
Ready to start giving
After you fund the account, you can begin your grant recommendations. A ‘grant recommendation’ is the terminology for the giving to a charity of your choice from your donor-advised fund. The donor-advised fund can be used to give to multiple charities at different times and in different amounts. You have flexibility because the account is still under your control. However, since you are no longer the owner, you cannot take money out for non-charitable purposes.
The company housing your donor-advised fund is called the custodian. As you recommend grants to various charities, your custodian keeps close records and prepares your necessary tax forms. The idea of keeping all of your charitable giving records in one place can be appealing, especially if you are giving multiple times throughout the year to numerous charities. You do not receive additional tax benefits for recommending grants. Your deduction is available using the tax form 8283 when you initially fund the DAF or add to it.
The simplicity of managing a donor-advised fund is an advantage over giving directly to charities themselves. Your history of giving from the donor-advised fund and contribution history is all in one place. When April 15th rolls around, housing all of your charitable records in one place can be priceless.
Nothing is free…
There are costs involved. Typically, there will be three types of expenses the donor-advised fund is subject to by the custodian. Again, they aren’t your costs since you aren’t the owner after the transfer. To allow the account to grow as much as possible, most custodians advertise their low-cost management of donor-advised funds. The three costs include a maintenance fee, although it may be waived if the account is more than a certain dollar threshold. The second cost is an administrative fee for operating expenses. The final cost is the investment fee, which refers to the expense ratios of the investments themselves.
Speaking of investments, just like grants, you may recommend investment allocations. The donor-advised fund grows tax-free. Once you have transferred securities to the account, you may reallocate the investments without tax consequences. Many custodians have socially conscious investment options allowing you to give back in a sense while the balance is growing before you have made a grant recommendation. The socially responsible investment options are two-fold; they have the purpose of earning an investment return and contributing to a specific cause. The targeted causes can range from environmental, to social justice, to religious beliefs.
The ability to recommend investment allocations is another advantage the donor-advised fund has over giving directly to a charity. Due to the nature of the account being an investment account, you can continue to grow your donation (dependent on your asset selection) to get more charitable bang for your buck. You are setting up the account for future giving while getting a potentially sizable tax benefit when you fund the account.
What investments you may transfer to your donor-advised fund is custodian specific. The custodians want to help you fund your account and have much broader abilities to house complex or non-traded investments than most charities. If you have a complex asset with appreciation or even a stock with appreciation, you will have a more significant impact by transferring that security to a donor-advised fund. By transferring the security without selling it first, you have 100% of the value available for charitable use. If you were to give directly to a charity and they could not accept the security, you would have to sell and be subject to capital gains tax, thus reducing the charitable impact you are making and increasing your tax burden.
The timing of when to create a donor-advised fund is unique to your goals and your financial picture. Often it brings the most tax benefit when you are in your highest-earning years. The deduction limitation based on your AGI should not deter you from donating more than that amount to your donor-advised fund. There is a five year carry forward for the amounts more than the AGI limitations.
If you know someone interested in maximizing their giving via a donor-advised fund, please share this blog with them.