Donor-advised funds (DAFs) have been on the up-tick over the past decade. According to the National Philanthropic Trust 2019 Donor-Advised Fund Report, the sky-rocketing growth has led to nearly double the amount of recommended grants—over $23 billion—to qualified charities over the past five years.
So, what are donor-advised funds, and why are we seeing this spike in growth?
What is a donor-advised fund?
A donor-advised fund is a charitable-giving vehicle that allows high net worth individuals to make impactful philanthropic contributions and receive sizeable tax deductions. These funds are flexible 501(c)3 accounts that can be used to set up legacy planning. employee giving, or nonprofit grantmaking, all funded with either cash, appreciated securities or other assets.
The way it works is a “charitable sponsor”— a tax-exempt charitable organization—is responsible for managing the donor-advised funds, ensuring all-encompassing regulatory compliance, and administering the funds to appropriate charities.
DAFs are versatile funds and can be used in a number of ways, where we are seeing trends setting and changing among different generations, the state of economy, etc. The DAF Report states that these emerging models are more focused on staying in cash with smaller charitable grants, with no regulated minimum. While traditionally, DAF have been sculpted with investment options to withstand lifetime and multi-generational giving.
What are the benefits of a donor-advised fund?
Donors of DAFs may be eligible to receive five primary tax benefits, as noted below.
- Income Tax Deduction – Donors receive an immediate income tax deduction in the contributing year for making contributions to nonprofit organizations. Donors are eligible to contribute up to 60% of their income into a fund, up to 30% of income for non-cash gifts, and up to 50% of stacked cash and non-cash gifts. If a donor contributes more than the tax-deductible limit in a single year, they are allowed to carry forward the unused deduction for up to five additional years.
- Tax-Free Investment Growth – If a DAF is invested before its distribution, the investment grows tax free and builds overtime, allowing more money to become available for charitable distributions over the life of the fund.
- Tax-Free Capital Gains – If a donor invests non-cash items, such as securities, real estate, or any other illiquid assets, the donor is generally not subject to capital gains tax on the market growth of those appreciated assets.
- Alternative Minimum Tax (AMT) – Contributing to a DAF is another way to reduce your tax burden if you are required to pay alternative minimum tax. A taxpayer’s contribution to the fund will reduce their AMT impact.
- Estate Tax – Donor-advised funds will not be subject to estate taxes.
Types of allowable contributions
There are a number of different ways in which a donor may contribute to a DAF. The following list outlines potential types of donations.
- Cash
- Stocks
- Mutual Funds
- Privately-held stock
- Municipal Bonds
- Pre-IPO shares
- C Corp or S Corp stock
- LLC & LLP Interests
- Cash Value of Life Insurance
- Real Estate
- Annuities
- Private foundations
The Downsides of a Donor-Advised Fund
While there are many benefits to DAFs, there are downsides to this type of investment as well.
Donors have less control over the allocation of funds. They’re able to make recommendations to the charitable sponsor that manages the fund, but nothing is set in stone as to when, where, or how the funds will be distributed.
And unfortunately, even though the money derived from the donor, the donor cannot make a binding agreement with an organization because the money isn’t technically the donor’s once it hits a DAF.
Is a Donor-Advisor Fund Right for You?
For many individuals, charitable planning is a top priority. Creating a charitable fund can be a rewarding philanthropic venture, one that can establish a legacy. It can also be a simple means of protecting your charitable assets for an optimal timeframe. For example, “bundling” gifts (combining multiple years worth of donations) into one gift allows taxpayers to meet and exceed new thresholds for itemizing in order to claim an income tax deduction in the distribution year. Bundling helps in the tax reform era due to the increased standard deduction amount.
If you have any questions on donor-advised funds, other investment options, or charitable gifting plans, please contact me at stu@eaglerockfinancial.net.
Stuart Steinberg, CFP, CPA, MBA has been working with families and their money lives since 1988. He can be reached at 61 Water Street, #2, Newburyport, MA 01950 and at (978)864-9581 and stu@eaglerockfinancial.net
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. This information is not intended to be a substitute for specific individualized tax advice. We suggest you discuss your specific tax issues with a qualified tax advisor.
Securities and Financial planning offered through LPL Financial, a registered investment advisor. Member FINRA www.finra.org / SIPC www.sipc.org.