This is my complete guide to donor-advised funds (DAF) in 2021.
In plain English, I’m sharing exactly what donor-advised funds are.
I’m also sharing unique tips for maximizing the tax benefits and how to find the best DAF provider.
If you want to give more to charity this year while also lowering your tax bill, this guide is for you.
Are you a philanthropist? You might not think so.
“Philanthropy” sounds like something only rich and famous people do.
In the United States, we think of donors like Bill and Melinda Gates, Oprah Winfrey, and Warren Buffett as the titans of public charity – not us.
Still, if you’ve kept on giving regularly to your favorite public charities, you are an American philanthropist too. It’s just that donors giving six or seven figures to public charity still enjoy major tax breaks.
Those of us donating in the three or four figures?
Generous tax breaks for supporting our favorite nonprofits are now fewer and farther between.
For example, let’s say every year you donate $10,000 to your local church.
Since the 2017 Tax Cuts and Jobs Act (TJCA), this $10,000 donation is probably no longer enough for you to claim an itemized deduction on your tax return.
As such, you receive no tax benefit.
That’s one way a donor-advised fund (DAF) can come in handy.
While the primary goal of giving to charity is to support a good cause, if we can get a tax benefit from the IRS, it’s icing on the proverbial cake.
If you’re charitably inclined, a DAF may help you enjoy some of the tax breaks you used to receive before the 2017 TCJA. It can also help you better manage your annual giving within your overall financial plans.
All this, without having to be a Rockefeller to get a tax deduction!
What is a Donor-Advised Fund?
Much like a mule is a cross between a donkey and a horse, the DAF is an interesting animal.
You set up a DAF in much the same way you do any other investment account, and then fund it with money you’ve earmarked for charity.
While the money awaits its final distributions, it can be invested (in low-cost mutual funds, for example) and/or generate interest, like any other investment.
But the DAF is more than just an investment account; it’s also like a miniature nonprofit foundation. Rather than setting up the account at a traditional brokerage house, you establish it with a nonprofit sponsoring organization offering DAF services.
In short, as a cross between an investment account and a public charity, a DAF is a sturdy, little giving vehicle you can use to continue supporting your favorite charitable causes.
You donate to your DAF, and then you (the donor) advise the sponsor on when and where to distribute the money. Thus the name: donor-advised fund.
It’s worth emphasizing, once you put money into a DAF, it no longer belongs to you. You’ve just made a charitable contribution to the nonprofit sponsor.
But you (and only you) get to make grant recommendations on how to distribute the money moving forward. Until then, the money typically sits in your DAF, where it can earn interest or market returns.
What is the Difference Between Donor-Advised Funds and Private Foundations?
Why bother with a donor-advised fund? Why not just give directly to the charities of your choice?
While there are a number of ways a DAF can help you better plan and manage your annual giving, its most popular appeal is its potential to lower your tax bill, without having to establish a complex and costly foundation of your own.
We’ll cover that tax appeal in a moment. First, what’s the difference between a DAF vs. a private foundation?
Either structure can be powerful giving vehicles you can use to reduce your tax bill. But there are a few key differences.
- Better suited for ongoing, multimillion-dollar giving
- Can cost tens of thousands of dollars (or more) to set it up
- Often requires you to personally employ a team of dedicated stewards to manage through the years and across multiple generations
- Cost-effective to establish
- Can be funded with a few thousand dollars
- Doesn’t require a team of people and typically gets closed once it’s served its purpose
In short, think of a DAF as a thrifty little planned giving program for regular folks like us.
Are Contributions to a Donor-Advised Fund Tax-Deductible?
While many taxpayers have never heard of donor-advised funds, the National Philanthropic Trust reports that the first DAFs were opened back in the 1930s.
Like a slumbering giant, the DAF didn’t become a popular giving vehicle in the United States until the 2017 TCJA made it much harder to lower your tax bill by itemizing your annual contributions.
As a donor at heart, you’re still going to give as much as you’re able. But fewer tax breaks from the IRS might mean you’ll have less left to give away.
A DAF can help you continue your usual annual giving, and get some of those extra tax savings after all.
TO ILLUSTRATE: Let’s say you and your spouse donate $10,000 annually to your favorite public charities. Until 2018, by reporting your charitable contributions as itemized deductions, you could lower your Federal taxable income (your adjusted gross income, or AGI) by most or all of the same amount, earning an immediate tax deduction.
But then, along came the TCJA. Now, to receive a charitable tax deduction, your total itemized tax deductions must exceed the standard deduction, Otherwise, you’ll not receive any tax benefits for these contributions.
In 2020, the standard income tax deduction is $24,800 for a couple filing jointly, which means you don’t start receiving an extra tax break until your charitable giving (plus other itemizable expenses) exceeds that figure. In 2021, that figure increases to $25,100. Thus, a $10,000 annual donation typically yields no additional tax advantage under the TCJA.
How do DAFs help?
Instead of directly giving $10,000 annually to your favorite causes for the next five years, you could put $50,000 into a DAF this year.
You then report the $50,000 charitable contribution as an itemized deduction and maintain your usual giving levels moving forward from your DAF.
Remember, once you add money to your DAF, you’ve just made a donation to a charitable organization. You can then make grant recommendations to distribute the money over as many years as you’d like.
Those are the basics. Now let’s take a closer look at some of the possibilities.
5 Scenarios When Donor-Advised Funds Are a Good Idea
The IRS considers each calendar year in isolation. They don’t care what you’re planning to do in the future, as long as you accurately report this year’s taxable income.
Your financial advisor can help you take a longer view, employing strategic thinking and careful year-end planning to make the most of a DAF.
Here are five funding strategies to consider.
Super Funding or Front-Loading
Superfunding or front-loading means contributing several years of giving in advance.
If you’re routinely giving to your favorite charities anyway – and you can afford to front-load your giving with a DAF – you can potentially realize extra tax savings that would otherwise be left behind.
High/Low Tax Year Planning
To decide when and how to fund a DAF, consider your big-picture tax-planning.
When you front-load your DAF, you’ll use the donation to itemize deductions in the year you fund the account.
As such, it helps to make that contribution in a high-tax year, so you get the highest tax savings back from your benevolent buck.
TO ILLUSTRATE: Say you’re getting ready to retire. Right now, you’re in your peak income years, after which, your taxable income is likely to drop precipitously for a while. What better time to establish a DAF, to offset the high tax bracket you’re currently in? Once your income is lower, you can use your DAF to keep giving, without having to dip into retirement reserves.
In this scenario, if you plan to continue giving $10,000 a year to the Capitol Land Trust (a charity we personally support), you could use a DAF to essentially claim 5–10 years’ worth of donations while you’re still in a top tax bracket.
In other words, you would put $50,000–$100,000 in a DAF, claim the entire tax benefit while in a peak tax year, and then distribute the money to your favorite charity at your usual $10,000 a year.
This will help you pay fewer taxes during your high-tax years. In the year you contribute to your DAF, it will also be enough to get you past the cap on itemized deductions.
Contributing Appreciated Assets
You can dramatically improve the tax benefits of a DAF by funding it with highly appreciated stock, real estate, and similar assets.
This can eliminate the burdensome capital gains taxes you’d otherwise incur when selling highly appreciated holdings out of taxable portfolios.
TO ILLUSTRATE: A few years ago, you bought 10 shares of Tesla stock in your taxable account at $50/share. Lucky you! But if you sell those shares today, the steep capital gains taxes could kick you into an overall higher tax bracket. Instead, you could transfer those shares into a DAF. If you sell them there, the gains are just as real, but they’re also tax-free.
Put another way, if you had otherwise sold $10,000 of Tesla stock, and then donated the cash to charity, you’d create thousands of dollars of taxable gains. By giving the Tesla shares directly to your charity via a DAF, you completely skip the taxes on the sale.
While you can use this same strategy to donate shares directly to a charity, many local charities are not set up to receive stocks, so the DAF can facilitate it.
Pair With a Roth Conversion
We call this strategy the two-step Roth-DAF tango.
STEP ONE: Let’s say you’d like to convert some of your traditional IRA assets into a Roth IRA. Once converted, your Roth assets grow tax-free, and you get to withdraw them tax-free in retirement. But, there’s a twist: You must pay ordinary income tax on the assets when you convert them to a Roth. So …
STEP TWO: Open a DAF that same year, and super fund it in similar amounts. Voila, properly executed, you can offset the Roth conversion tax bill with a contribution to a DAF.
The DAF can also be instrumental if there are organizations you’d like to support anonymously.
When you advise your DAF sponsor to distribute donations to various charitable organizations, you can request your name be withheld. So, it will appear as if the DAF (such as Fidelity Charitable) made the donation, instead of you.
The Disadvantages of Donor-Advised Funds
So far, we’ve covered the potential benefits of a donor-advised fund – especially the tax benefits. As you might imagine, there are caveats to consider as well.
Here are three questions to ask yourself before funding a DAF.
Are you sure? When you put money in your DAF, you are making a charitable contribution to the sponsoring organization.
While you advise the sponsor on how to distribute assets, the money is no longer yours to spend on anything other than charitable giving. There is no changing your mind about that later on.
Do you have enough to give? If your annual giving is more modest (e.g. less than $2,500 per year) it’s unlikely a DAF will help.
Remember, there’s no tax benefit unless you deposit significantly more to your DAF than the standard tax deduction in the year you make the deposit.
Plus, while a DAF is much more cost-effective than a full-blown private foundation, there are typically a few administrative expenses involved.
Do you have too much to give? On the flip side, if your annual giving is in the range of $100,000 or more, it may be worth exploring other options such as a:
- Charitable remainder trust (CRT)
- Charitable lead trust (CLT)
- Private foundation
These solutions might offer better tax- and legacy-planning tools beyond what a DAF can provide.
In short, a DAF is not ideal for everyone. And like every tax strategy, DAFs need to be coordinated with your CPA as part of a comprehensive, multi-decade tax plan.
Even when they are a good fit, there are a growing number of DAF sponsors to choose from. Let me try to help you make a smart choice.
How to Find the Right Donor-Advised Fund
In its 2019 report, the National Philanthropic Trust analyzed nearly 1,000 DAF charitable sponsors, managing more than $37 billion in contributions as of 2018.
Out of all the possibilities, how do you identify the best donor-advised fund providers for you and your circumstances?
Of course, the provider should be reputable, with the resources and experience necessary to take good care of your donation.
Beyond that, here are 7 critical questions to ask when choosing a donor-advised fund.
1. Who does the donor-advised fund sponsor serve?
There are three broad categories of nonprofit organizations that sponsor DAFs:
- National charities: National organizations include independent ones such as the National Philanthropic Trust. Popular account custodians such as Fidelity and Schwab also offer charitable institutions. Fidelity Charitable offers Fidelity donor-advised funds, and Schwab Charitable offers Schwab donor-advised funds. These sponsors serve donors nationwide and can distribute donations to nearly any qualified public charity.
- Community foundations: Big cities (such as Seattle and Tacoma) and other community organizations may offer DAF programs to “carry out charitable interests for the benefit of residents of a defined geographic area.” [Source]
- Single-issue charities: As the name suggests, these DAF sponsors are established by, and intended to fund a single charitable intent, such as a faith-based, environmental, or social justice cause.
2. What are my investment options?
National charities such as Fidelity Charitable enable you to invest your DAF assets in nearly anything. The options are very similar to the investments available for your “regular” investment and retirement accounts.
Community foundations and single-issue charities often have fewer options.
If you would like to advise the donor-advised fund sponsor to invest your DAF assets in the same way you’re investing the rest of your holdings, a national charity may be optimal.
3. What types of assets can the DAF sponsor accept?
Some DAF sponsors can accept assets such as stock shares or real estate “in kind” (without your having to sell the asset first). Others cannot.
As we described above, donating highly appreciated holdings in kind is one way to reduce your tax bill by eliminating capital gains taxes otherwise due upon sale.
If you want to employ this strategy to fund your DAF, be sure to select a sponsor who can work with you or your advisor on that.
4. How much should I expect to pay in fees and other costs?
Of course, all else being equal, you want to pay the fewest fees for the best service.
If a DAF sponsor’s costs are higher than usual, be sure to take a closer look before selecting them. Fees can include:
- Account management fees: For example, Fidelity Charitable currently charges administrative fees that start at $100 or 0.60% of the average account balance, whichever is greater. Its tiered fees decrease as your account balance increases.
- Investment fees: If you advise the sponsor to invest your money while it awaits distribution, you’ll pay the usual investment costs. Fidelity Charitable suggests expecting fees between 0.015%–0.97%. With so many good low- to no-cost choices these days, there’s no reason to select anything more costly than that.
- Advisor fees: If you engage your advisor to proactively manage your DAF within your wider wealth management, they may include these assets in your total portfolio, subject to their usual fees. At Jarvis Financial, we do NOT charge clients to manage their DAFs; it’s a small way for us to support their charitable efforts.
- Other: DAF costs are typically relatively straightforward. But it could never hurt to ask, and read the fine print, to ensure there are no other unusual “gotchas.”
5. What’s the minimum contribution size?
Some DAFs, such as Fidelity Charitable, have no minimum initial contribution requirements.
That said, as touched on above, DAFs don’t generally add enough value to be worth their costs unless you’re planning to fund them for making annual donations in the range of $5,000 or more. Plan accordingly.
6. What reputation does the DAF sponsor have?
It’s rare for a DAF sponsor to “go out of business” through inept management or intentional malfeasance. But there are ways to compare and contrast DAF sponsors.
For example, you can look up:
- How long they’ve been operating
- If they have current audited financial statements or a Form 990 to examine
- What its leadership team looks like
We recommend working with your financial advisor, CPA, attorney, or other professional to help you do your due diligence.
7. What else should I be aware of?
While most DAF sponsors share much in common, each may have additional rules of engagement worth being aware of before you sign on the bottom line.
Depending on your circumstances, look for how the sponsor will handle the particulars, such as:
- How or if your DAF can outlive you
- How readily you can transfer the assets to a different sponsor if desired
- Whether there are other minimums, maximums, or caveats to be aware of
Is a Donor-Advised Fund Right for You?
On the surface, DAFs are relatively affordable and easy to set up. They help you continue to give generously to your charitable organizations of choice, while gaining back some of the tax breaks that used to be available before the 2017 TCJA.
They also can offer you and your financial advisor an additional tool for managing other aspects of your charitable intent.
Let us know if you’d like to learn how you might best take advantage of the benefits of a donor-advised fund. We’d be happy to give you a guided tour!
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