A donor-advised fund may sound like something only for the ultra-wealthy, but it’s actually open to anyone who makes charitable contributions. The donor-advised fund is one of the most tax-efficient ways to donate money to charity, making it the fastest-growing charitable fund in the US, according to Fidelity Charitable.
A donor-advised fund is a charitable account that allows a donor to make grants to a charity over a period of years. They can be relatively inexpensive to create and maintain, and a donor-advised fund offers donors some ability to manage their tax situation through donations. The fund can also be invested, so it can grow as you decide which charities to support.
Here’s how a donor-advised fund works, why it can be an attractive option for giving, and some key advantages it has over a charitable fund.
How a donor-advised fund works
With a donor-advised fund, an individual makes a charitable donation to a fund sponsor, such as a nonprofit organization such as Schwab Charitable, associated with Charles Schwab, or Fidelity Charitable, associated with Fidelity Investments. The donor receives a tax deduction in the year the original fund was established, and then the money can be distributed by the fund’s sponsor in subsequent years, on the donor’s advice.
Think of the fund as a tax-free pot in which charitable donations are held, says Richard Mills, an estate planning attorney at Smith Haughey Rice and Roegge, a law firm in Michigan.
Potential donors should know that once the fund is established, the money cannot be withdrawn. When the fund is established, the donor sets the rules for how money is donated. But technically the sponsor controls the fund and the donor’s advice on what to fund is non-binding.
“That said, it is rare for the sponsoring organization’s board to exercise its variance powers and ignore the donor’s advice,” says Mills.
“The funds that are not awarded each year can be invested and grow over time, making it possible for an initial charitable gift to a fund sponsor to ultimately yield much more than the initial gift in total gifts going to charities. ” says Jeff Hamond, vice president and director of philanthropy at Van Scoyoc Associates, a government relations firm in Washington, D.C.
But to get a tax benefit from these funds, you’ll need to itemize your deductions, and that means deductions that exceed $27,700 for a married couple or $13,850 for an individual taxpayer in 2023. If you don’t meet at least those thresholds the donor-advised fund offers no net tax benefit. The thresholds will increase to $14,600 for individuals and $29,200 for a married couple in 2024.
For example, a couple might have an itemized deduction of $20,000 and decide they want to set up a fund with a $50,000 contribution and take the additional tax deduction. Together, these amounts would push their itemized deductions over the threshold, making the plan tax-efficient. However, because their itemized deductions before the charitable gift were below the threshold, they will only receive a net benefit of $42,300 from the donation based on the 2023 thresholds.
Why a donor-advised fund can be attractive
“Donor-advised funds have grown tremendously in popularity over the past 10 to 15 years because they are easy and inexpensive to create, just like opening any other type of investment account,” Mills says.
Mills says financial advisors suggest clients include them in financial plans, while attorneys include them in their clients’ estate plans. He notes that they are easier and cheaper than other similar avenues, such as a private foundation or a charity.
But this type of fund offers a range of other benefits that can make it an excellent choice for donors.
Tax management
The prospect of a changing tax landscape may prompt many taxpayers to establish donor-advised funds. The Biden administration has made mention of raising capital gains tax rates for wealthier taxpayers, and has also floated the idea of dramatically reducing the amount of money that can be excluded from the estate tax and phasing out increases in the cost basis for inherited assets purchase.
While it’s still unclear what steps a Biden administration might take now or in a possible second term, it has campaigned for higher taxes on higher incomes, meaning a well-thought-out plan could lower your taxes. Whichever way the tax winds blow, a donor-advised fund may be able to help.
Simplicity
With a donor-supported fund, you can create one plan to manage all your charitable gifts, while the fund’s sponsor can handle all the administrative work.
“Some donors like the simplicity of being able to make one charitable gift and keep one gift certificate, and then let the fund sponsor handle multiple charitable gifts from that fund without the donor needing additional justification,” Hamond says.
Anonymity
If established through a community foundation, a donor-advised fund can be used to make anonymous gifts, allowing the donor to avoid attention.
Advice
The fund sponsor can help the donor decide which charities to support or how to manage the donation process, providing valuable assistance to newer or less informed donors.
Flexibility
“Other donors may have a liquidity moment where they want to give money to a charity, but don’t know exactly which charities to support,” says Hamond. “The donor-advised fund allows the donor to make the initial gift now and provide grants in the future.”
Donors can therefore claim the tax benefit now and decide later what to donate the money to.
Educational giving
“Young and adult children can be involved in the gift advisory process and have the opportunity to act as a fund advisor following the death, incapacity or resignation of the parent,” says Mills.
Donor-advised fund versus charitable fund
A donor-advised fund differs from a charitable fund in a number of ways, depending on the trust. But a key difference is that with a trust the individual donor can still benefit in some way, while with a donor-advised fund the money is essentially given away without ownership.
“With a charitable lead trust, a portion of the principal is distributed to your beneficiaries,” says Hamond. “With a charitable remainder trust, you receive an annual income and the charity receives money later.”
“With a donor-advised fund, it’s a complete charitable gift,” he says. “There is no continued ownership or control, and no revenue flow back to the beneficiaries.”
Private foundations are another option for charities, although they do not offer the convenience or simplicity that a donor-advised fund provides.
Because of their complexity and expense, a private foundation only makes sense for very wealthy families, Mills says, “especially given the dramatic increase in the amount of the estate tax exemption over the past two decades.”
“Middle-class and moderately wealthy families can do the same with a donor-funded fund at a much lower cost,” he says.
Types of assets that can be contributed to a donor-advised fund
If you’re considering making a charitable contribution, a donor-advised fund can be a versatile tool for accepting a range of asset types. This includes:
- cash
- shares
- investment funds
- bonds
- property
- private business interests
- cryptocurrency
- personal tangible property such as art or antiques.
The type of assets you donate can have different tax consequences. For example, if you donate appreciated assets such as stocks or real estate, you may be able to avoid capital gains taxes and potentially claim a tax deduction based on the fair market value of these assets.
However, bringing complex assets into a donor-advised fund, such as private corporate interests or cryptocurrency, may require additional steps and careful due diligence. Before donating assets to a donor-advised fund, it is critical that you understand the tax implications, limitations and procedures involved. As always, it is advisable to consult a tax or legal advisor to ensure you get the most out of your charitable contributions.
In short
If you expect changes to the tax code during a Biden presidency, those looking to maximize the benefits of charitable giving may want to look to donor-advised funds. So consider adding it to your toolbox as you plan your estate and manage your tax situation.
Given the complexity associated with these planning issues, it is wise to consult tax and estate advisors to address your specific situation.
