Recently, a client contacted us and inquired about donor-advised funds (DAFs).
She asked whether this type of account made sense for her situation. DAFs have grown in popularity over the past few years, but many people are unfamiliar with how they work.
I decided to use my client’s inquiry as an opportunity to expand my own understanding of these tools, and how they can help investors enhance their charitable giving.
What is a DAF?
A DAF is a charitable savings account that an individual or couple (commonly known as a donor/s) can set up through a qualified institution, such as Schwab Charitable, Fidelity Charitable or Vanguard Charitable, or other “umbrella charities,” including community, single-issue or religiously-affiliated organizations.
With a DAF, a donor can receive an immediate charitable contribution deduction the same year that they make an irrevocable donation to their account. The donor may also be able to receive additional deductions for future deposits into their account.
Although contributions to a DAF are irrevocable and no longer the donor’s property, the donor can still give direction regarding the investment choices, and can also provide grants — within the gifting year and beyond — to qualified charities of their choice.
So what’s all this talk about DAFs, anyway?
According to the IRS, DAFs have existed in some form since the 1930s.1 Over time, they have become one of the fastest-growing vehicles for charitable giving. The National Philanthropic Trust (NPT)’s 2014 Donor-Advised Fund Report stated that the amount of charitable assets in DAF accounts now totals over $50 billion. The total contributions to DAF accounts in 2013 totaled $17.28 billion, an increase of 23.5 percent from 2012 to 2013. The report also found that the total value of grants from DAF accounts to qualified charities totaled $4.14 billion in 2013.2
How does a DAF work?
There are five steps to the gifting process3:
1. You make an irrevocable contribution of personal assets.
2. You immediately receive the maximum tax deduction that the IRS allows.
3. You name your DAF account, advisors, and any successors or charitable beneficiaries.
4. Your contribution is placed into a DAF account, where it can be invested and grow tax-free.
5. You can recommend grants from your account to qualified charities.
Should you consider a DAF?
Given the recent increase in activity related to DAFs, it may seem like the perfect time to set up an account for yourself. But first, it’s important to evaluate your financial situation and assess whether a DAF is the most appropriate solution. If any of the following are aligned with your charitable planning objectives, a DAF account could be a beneficial tool for you:
A DAF could reduce the tax impact you incur on appreciated stock.
Consider this hypothetical example: Don and Nancy own stock that has appreciated significantly and now have a gain of more than $30,000. Instead of writing checks to their favorite charities each year, Don and Nancy can move part or all of this stock to a DAF.
Once the funds are in the DAF account, they can sell the stock without a taxable consequence, and can also receive an immediate tax deduction on the market value of their stock as a charitable contribution.
Moreover, these accounts can also help donors receive immediate tax benefits. Let’s say that Don and Nancy have decided to sell their business for $4.5 million this year. To help offset part of the taxes from the sale of their business, they decide to contribute $200,000 to a DAF.
As a result, they are eligible to receive an immediate tax deduction on the contribution to help reduce their tax burden within the current year. However, not all of that $200,000 has to go to charity. Instead, the funds that Don and Nancy contributed to their DAF can be invested and grow over time. They can also choose to make grants out of their account at any time.
Are you planning to leave a charitable legacy? A DAF can be a great vehicle for housing the funds you plan to pass down. Let’s say that Don and Nancy want to teach their children the importance of charitable giving. To accomplish this, they decide to set up a DAF and have annual meetings with their children to determine which charities they would like to support that year.
When compared to private foundations, DAF accounts tend to be easily accessible and fairly simple to set up. In the long term, charities may receive a greater contribution, due to appreciated assets and dividend income received over the life of the account.
To determine whether a DAF is the right option for you, consult with a financial planner, or better yet, a Certified Financial Planner (CFP®). He or she will be able to help you coordinate with your tax professional and plan the best implementation option for your personal situation.