I've heard a lot about donor advised funds. Are they a good way to structure my charitable giving while getting tax benefits?
A donor advised fund is a relatively simple, flexible and tax-efficient way to grow your investments and give to charity.
Think of it as a dedicated account for your charitable giving. It allows you to contribute cash, securities or other assets to the fund and get an immediate tax deduction. You maintain control of your investments, which grow tax-free since they are charitable donations, and make grants to the IRS-qualified charity you choose.
You can open a fund with as little as $5,000. All the money you put in goes to charity (once it's in, you're not getting it back), but you get an immediate tax break. Deciding how the money gets distributed is up to you: dole out $2,000 every year to a bunch of different charities, for example, make a significant gift of a $1 million ten years from now, or create a fund as a legacy for your children to continue to distribute after your death.
"Donor advised funds are one of my go-to strategies for reducing taxes for people who are already charitable," says Patrick King, a certified financial planner with Transformative Financial.
Here's how to figure out if a donor advised fund is the best way to accomplish your giving goals.
Opening a fund is relatively easy. You can do it through many public charities such as Fidelity Charitable, Schwab Charitable, the National Philanthrapic Trust or a community foundation. You just need a Social Security number and at least $5,000 to invest, though some charities may have higher minimums.
If you donate cash, you're eligible for a tax deduction of up to 60% of your adjusted gross income.
But the real appeal of donor advised funds for many investors is that they might accept a wide variety of donations — including publicly traded securities, restricted stock, mutual fund shares, cryptocurrencies, private equity and hedge fund interest, real estate or privately held C-corp or S-corp shares — that charities often cannot accept.
"Donor advised funds have gotten to a place where they can take more complex assets," says Tina Davis Milligan, managing director of family office services at BMO wealth management. "A lot of clients have large capital gains and they may give more than they planned because it becomes more meaningful."
This is where investors can find very favorable double tax benefits. If you give these appreciated assets directly to a donor advised fund, you can, first, avoid paying capital gains tax and, second, take an additional income tax deduction in the amount of the full fair market value of the asset, up to 30% of your adjusted gross income.
A donor advised fund could make a great deal of sense right before retirement, says Michael Troxell, an investment adviser and certified public accountant with Modern Financial Planning.
"While a near-retiree is still working and in a high tax bracket, they could contribute a large amount of charitable giving (say 10-20 years worth) to a DAF in order to maximize the tax benefit while being able to distribute the funds to charitable organizations over the course of their retirement," says Troxell.
A good time to establish or add money to your fund is after a significant swell in assets — maybe a retirement payout, an unusually high bonus or the sale of a company.
"When a client has a big year, a donor advised fund can 'front load' their charitable giving for future years while providing a large charitable deduction in the year they need it most," says King.
Like any investment, the value of a donor advised fund fluctuates. Don't get in over your head with a fund that includes costly or risky investments, says Dan Stous, the director of financial planning at Flagstone Financial Management.
Another mistake is opening a DAF with a high-cost provider. "There may be some premium services offered by some providers to justify a fee, like acting as a consultant to connect the giver with charities in their community, or talking through complex gifting situations, but givers should know what they're paying, and know what they're getting for that fee."
But the biggest pitfall with a DAF is to simply view it as an investment or tax-reduction vehicle, says Stous.
"Ultimately, donor advised funds are a way to give to charity," he says. "If your primary reason for putting money in a fund is something other than a generous heart, you're setting yourself up for disappointment."