Donor advised funds: Tax Benefit, Growth, and Control
Donor advised funds have been around for decades, but they’ve only become wildly popular vehicles for charitable giving over the last several years. They offer immediate tax benefits as the assets or funds in the donor advised fund convey a tax deduction in the year in which they are gifted. Inside the fund, the assets can grow tax-free and do not have to be distributed immediately to a charity.
How popular are they? Total assets in donor-advised funds have more than quadrupled over the past decade, to more than $140 billion. Roughly $1 of every $8 given to charity in America now goes to a donor-advised fund. (1)
The funds offer an extremely flexible way to craft a gifting strategy that can allow for the gift to be invested and managed, to potentially grow over time, and for the gifter to maintain control over the assets.
understanding donor advised funds
A donor advised fund (DAF) is a savings vehicle that allows for charitable donations and tax benefits, all while the donor still has control over where the assets are to be donated. Donor advised funds are irrevocable, meaning that you can’t withdraw funds after donating. Still, you can specify how the donation is to be invested and to which charity you’d like to donate.
Given their versatility and flexibility, DAFs have become a popular choice for those with a charitable heart. According to research from the National Philanthropic Trust, contributions to DAFs in 2019 totaled almost $39 billion, an 80% increase since 2015. (2)
With donor advised funds, you aren’t limited to donating just cash. Acceptable donations range from stocks and bonds to bitcoin and private company stock. Donors can deduct up to 60% of adjusted gross income if donating cash and up to 30% of adjusted gross income if donating appreciated assets.
To make sure a donation qualifies for the full benefits, the fund administrator must be a public charity that falls under the qualifications of a 501(c)(3) organization.
How They’re Managed and How to Contribute to One
First, it must be opened at a qualifying sponsor. Some of the more popular national sponsor’s are located at Fidelity, Charles Schwab, and Vanguard. After selecting a sponsor, donors must make an irrevocable contribution to the fund. At that time, they can take the immediate tax deduction and begin naming beneficiaries and successors for the account.
After making a contribution, the sponsor firm then has legal control over the funds. Sponsor firms usually give you a lineup of investment options to invest the proceeds before they’re donated to your specified charity. Since the fund manages the money and handles the administrative tasks that come with donating to charities, administrative fees need to be considered when deciding on which sponsor to use, as those fees are deducted from the donor’s contributions.
contribution details and limitations
There are several rules you need to be aware of before making a charitable contribution. First, there is a limit to the amount you are able to deduct depending on the asset you donate and when you make the donation. See the chart below:
You are allowed to carry forward for 5 years any excess contribution that exceeds the limits in the above table.
For example, John has AGI of $150,000 in 2021. He donates $50,000 of Apple stock in 2021 to a donor advised fund. He is allowed to deduct 30% of his AGI which comes out to $45,000 for long term capital gain property such as publicly traded securities. He will carry forward $5,000 ($50,000 FMV – $45,000 allowable limit) for the next 5 years until the amount is exhausted.
Second, you are only able to receive a tax benefits of your charitable contributions if your itemized deductions are greater than your standard deductions. In 2021, the standard deduction for a married filing jointly couple is $25,100. If your charitable contributions total $5,000 and your other itemized deductions only total $15,000, you will not receive tax benefits for your donation as your total itemized deductions are $20,000 and the standard deduction is $25,100. Last, for 2021 there is a special rule for charitable contributions for ‘above-the-line’ deductions. A single taxpayer can deduct $300 ($600 if MFJ) of cash contributions if taking the standard deduction.
Timing your charitable contributions is crucial if you are looking to maximize the related tax benefits. The AGI and itemization limitations impose restrictions that require careful planning.
lumping contributions vs. spreading them out
It might be in your best interest to lump together annual contributions into a single year. For example, let’s say you’re a single filer who utilizes the standard deduction ($12,550 for 2021) with AGI of $100,000 and you make $4,000 contributions to your public charity every year. You are way under the AGI limitations ($60,000), but you’ve run into the itemization limitations. Since you’re taking the standard deduction, you can’t deduct your contributions. Well, instead of making the $4,000 contribution every year, you can instead make a lump sum contribution of $40,000 (10 years worth of contributions) in a single year. Now it makes sense to itemize since your donation of $40,000 is way higher than the standard deduction of $12,550.
when does it make sense to contribute to a donor advised fund?
There are many situations where it may make sense to contribute to a donor advised fund, but some of the most common are:
- If you own highly appreciated assets
- If you’re looking for a tax-deductible transaction
- If you want to make a sizable future donation
For example, let’s say someone bought Amazon stock when it was $10/share, and it grew to $3,000/share and they didn’t want to pay capital gains tax on the appreciation. With a donor advised fund, they could donate the stock, and no capital gains would be due.
The Pros and Cons of Donor Advised Funds
When contributing money to a donor advised fund, the donor receives an immediate tax deduction on the amount they contributed, even though the funds may not be distributed to a charity until a future date. This allows for greater control and flexibility when compared to making a regular donation directly to a charity.
Additionally, contributing to a donor advised fund makes record-keeping simpler than making multiple donations to different charities and keeping track of all the documents. This is because the fund can act as a “hub” for all donations, and it will record all contributions and provide a single tax document containing all information needed.
Though versatile, a concern amongst many donors is the fees associated with donor advised funds. For example, the fund might charge a 1% administrative fee, which is being taken directly out of the funds to be donated. The underlying investments may also have fees, so it’s important that you carefully evaluate where your money is going and how fees play a role in the donation.
Overall, donor advised funds are a versatile tool when it comes to making donations. They provide tax benefits and allow donors to choose where their money goes, all while those donations can grow tax-free until a charity is chosen. However, there’s more to consider than just the benefits, so to make sure it’s the right move to make for your financial situation, it’s recommended to talk with a financial advisor before establishing a donor advised fund.
(1) Frank, Robert. Billionaire philanthropist John Arnold says donor-advised funds are ‘wealth-warehousing vehicles’. CNBC. August 11, 2021.
(2) National Philanthropic Trust. The 2020 DAF Report. NPTrust.org