Donor-Advised Funds: Making Charitable Giving Strategic, Easy, Tax Smart
- Charitable gifts are a great way to show your support for your favorite causes, impact your community in a positive way, and reduce your taxable income.
- Donor-advised funds give you the option to make anonymous contributions and avoid solicitation.
- They're an accessible and low-cost alternative to private foundations.
Despite our best intentions, charitable giving can feel rushed and disorganized with the holiday season (and tax deadlines) taking center stage at year-end. But there's one alternative that allows you to meet your charitable giving goals, make grants at your own pace and reap potential tax benefits.
What is a donor-advised fund?
Simply put, a donor advised fund (DAF) is a charitable account that's managed by a nonprofit—typically a charitable organization founded by a financial services company, a community foundation or a university. You decide when and how much to contribute to the account and can direct grants to 501(c)(3) charities that are in good standing with the IRS. The custodian vets charities for IRS eligibility and sends out grants at your request. The custodian also manages the investment of the charitable assets based on your preferences. Some custodians offer a choice of investment pools and allow independent investment advisers to manage the assets of larger accounts. The custodian keeps complete records of contributions and grants for tax purposes, allowing you take a strategic approach to philanthropy.
Donor-advised funds have grown at a surprising rate despite slow economic growth in recent years. In 2012, assets under management grew by $7.21 billion, an 18.9% increase from the previous year.1 DAFs' growing popularity isn't surprising—they offer donors a tax-smart opportunity to give to their favorite charities with relatively low costs. Accounts can start as low as $5,000 or as high as $1 billion and deliver tax benefits for a wide range of gifts—from cash and appreciated securities to closely held shares and property. One of the most notable features of DAFs is how they uncouple the timing of the charitable tax deduction from the granting, which lets donors make one tax-deductible contribution at year-end and grant to charities of their choice on their own schedule. Donors can also maintain a level of privacy around their giving if they desire.
How do donor-advised funds compare to private foundations?
DAFs are a much simpler alternative to private foundations, which often require more administrative duties. Private foundations manage a board of trustees, hire administrators, file public documents, ensure annual disbursements meet the IRS requirement (5 percent of foundation assets) and pay excise taxes on investment income.
Upon opening a DAF account, incremental gifts can start at $100 and there are no annual disbursement requirements or public filings. Grants start as low as $50 and can be acknowledged or anonymous (a valuable feature for those who want to avoid publicity or solicitation). Administrative fees are typically less than 1 percent of assets under management and as low as 0.1 percent for the largest accounts.
|Private foundation||Donor-advised fund|
|Asset minimums||Generally recommended only for those with millions of dollars in charitable assets||$5,000|
|Startup costs||May be substantial (legal documentation, tax filings, other)||None|
|Ongoing annual expenses||May be substantial||Comparatively low|
|Privacy||Public disclosure of contributions and grants in annual tax filings||Transactions can be private|
|Tax deduction limits for cash contributions||30% of adjusted gross income (AGI)||50% of AGI|
|Tax deduction limits for securities contributions||20% of AGI||30% of AGI|
|Administration||Required recordkeeping, asset management||Managed by DAF custodian|
|Reporting||Required annual state and federal tax returns||None|
|Taxes||Excise taxes, up to 2% of annual investment income||None|
|Annual distribution requirements||5% distribution required annually||None|
|Professional asset management options||Yes||Yes|
Unique tax advantages
DAF contributions carry measureable tax benefits and are eligible for an immediate tax deduction. Cash contributions are deducted up to 50 percent of adjusted gross income, higher than the 30 percent maximum for contributions to private foundations. Gifts of appreciated assets, such as stocks, are deductible up to 30 percent, but only 20 percent for a private foundation. Both enjoy a five-year, carry-forward provision for excess deductions.
Contributions of appreciated securities with unrealized long-term capital gains (including IPO shares after restrictions are lifted) carry an additional tax benefit, as they enable donors to avoid capital gains taxes associated with the sale of these types of securities. This is an increasingly attractive benefit, as many donors have a portion of their portfolio in appreciated assets and they may want to consider donating them before donating cash.
For perspective, consider this example: Depending on the tax bracket, an investor holding stock with a long-term, capital gain of $100,000 could face a $15,000 or $20,000 federal tax bill if he sold his shares (plus an additional $3,800 if subject to the 3.8% Medicare investment surtax). That doesn’t even include state income taxes. By donating the stock to his donor-advised fund, he can avoid paying tax on the sale, have the full $100,000 value go to charity and realize a $35,000 charitable income tax deduction (assuming a combined federal/state marginal 35% tax bracket). The investor and the charity both benefit.
Extracting value from illiquid assets
The advantages of contributing appreciated assets to a donor-advised fund are not limited to publicly traded securities. Less liquid assets are usually accepted, including:
- Restricted and unrestricted stock
- Privately held securities
- Certain corporate stocks and pre-IPO shares
- Tangible personal property
- Cash value of life insurance policies and real estate
Contributions of less liquid assets are more complex. The custodian will need to outline how the assets will be turned into cash, which can then be disbursed to charities. The IRS also requires independent appraisals to be conducted for all non-cash gifts worth more than $5,000, so these types of gifts need to be valuable enough to justify the time and expense. Still, the largest custodians have become known for their ability to accept illiquid assets and provide charitable value to their donors.
Building a charitable legacy
DAFs are designed to make it easy for donors to bequeath their account and enable others to support charitable causes after their passing. Many donors take comfort in knowing that their fund may allow a surviving spouse, child, close friend, or trustee to continue supporting important causes. In doing so, they pass their commitment to philanthropy on to the next generation. Alternatively, some DAF custodians allow donors to recommend a recurring gift to their favorite charities after their passing.
Donor-advised funds are often used as a part of an estate plan, since assets donated to a charitable account are not part of a taxable estate. There are several tax-smart ways to add to an account at death, including designating a donor-advised fund as a beneficiary of a retirement plan, revocable or living trust, charitable trust or life insurance plan.
I hope this enhanced your understanding of donor-advised funds. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts.
1.National Philanthropic Trust, 2013 Donor-Advised Fund Report.
A version of this article was originally published in CalCPA’s September 2012 issue of California CPA.
Open a donor-advised account with Schwab Charitable™ or call 800-746-6216 to learn more.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
A donor’s ability to claim itemized deductions is subject to a variety of limitations depending on the donor’s specific tax situation. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.
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Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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