Due to the positive response to our blog article, New Tax Law, New Approach to Charitable Giving?, we’ve decided to delve deeper into some of the charitable giving strategies discussed. In this article, we take a closer look at donor-advised funds.
A donor-advised fund, or DAF, is an investment vehicle that is similar to a mutual fund, whereby your contributions are invested and grow tax-free.*
What makes a DAF an attractive option for so many is its simplicity and low costs to establish; immediate tax benefit; and considerable flexibility in your giving strategy.
Among the charitable giving strategies previously discussed, the DAF may be the easiest.
The only document you need to complete is the donor fund application, which you will receive from the financial institution that you select to administer the DAF. There are no legal documents to draft or trusts to set up, and regardless of how many nonprofit groups your DAF contributes to, you will receive a single tax receipt in the years you gift to the DAF – making your life and that of your tax professional much less complicated.
DAFs are relatively inexpensive to establish at many institutions.
While you will pay administrative fees for fund management and grant-making, the amounts of which vary by institution, there is no legal or accounting work required for the fund’s formation.
Once you establish your DAF, you may elect to hire an investment manager to oversee the DAF, which may require additional paperwork and additional fees.
The tax advantages are an attractive feature of a DAF.
You will receive the maximum tax deduction allowed by the IRS (subject to AGI limits) in the year of the fund’s formation. In addition, if your DAF allows you to make additional contributions of gifts or cash, you may receive an additional tax deduction in the year the supplementary gift was made, subject to adjusted gross income (AGI) limits.
DAFs offer a great degree of flexibility.
When you establish a DAF, you are not required to identify the charity or charities you intend to donate to; you can defer those decisions until after the fund is established as your philanthropic desires dictate. There is also a great degree of flexibility in how you fund the DAF: you can gift various types of financial assets, including stocks, bonds, cash, or even non-liquid assets such as real estate.
DAFs are a good option if you are taking a long-term view with your giving strategy. Your donations can be invested in equities and fixed income that may continue to grow over time*, tax-free, allowing you to increase your donations to the charitable organizations and nonprofit causes you care about, from your church to your alma mater to the homeless, and so on.
It’s important to remember that your contribution is irrevocable. Once you finance the DAF, the assets belong to the DAF and you cannot make withdrawals for non-charitable purposes. However, there is flexibility in your ability to change the charitable beneficiaries and/or the amount of the donation. For example, while you cannot take distributions from the DAF for your child’s college tuition, you can choose to make the university a benefactor.
Let’s look at a hypothetical example of how a DAF works.
“Pam” was a long-time employee of a Fortune 100 company, and in 2016 she retired with more than $300,000 in appreciated “A” stock with a cost basis of $74,000. Pam had a long history of charitable giving and was a devoted donor to her local church. Her charitable goal in retirement was to tithe $10,000 per year in “A” shares to her church, versus making her typical cash donations throughout the year.
Under the Tax Cuts and Jobs Act (TCJA) passed in 2017, only approximately $7,000 of her donation would be tax deductible in excess of the standard deduction. However, through her DAF, Pam was able to take a much larger tax deduction — up to her eligible adjusted gross income (AGI) limit. There is a 30% of AGI limit per year for gifts of appreciated securities. She also maintained a five-year carry forward.
The DAF allowed her to reallocate her shares of “A” company to a globally diversified portfolio that was less risky for her giving goals as well. The DAF also had a meaningful impact on other areas of Pam’s overall financial plan. She was able to convert more of her traditional IRA to Roth IRA than originally planned, as the DAF’s larger annual deduction offset the increased tax liability from the conversion.
Though simple in nature, there can be more to a DAF that a financial professional can unlock.
Although we’ve discussed the simplicity of establishing a DAF, there are still aspects that should be given careful consideration. Before making any meaningful investment and planning decisions, we recommend seeking the advice of a financial professional who understands how to maximize the potential of your DAF and can manage it based on your specific financial goals.
Working on your own, you may not have access to the largest range of investment options. A financial expert can also you guide you as to which of your assets are the most beneficial to gift, which provide the greatest tax benefit, and which have the best potential to meet your short- and long-term giving goals.
If you would like more information on other charitable giving options, we invite you to read the companion article, New Tax Law, New Approach to Charitable Giving?, or contact a MACRO Consulting Group advisor.
*Past performance is not indicative of future results. While an advantage of a donor-advised fund is the potential for investments to grow tax-free, there is no guarantee the value of the stocks, bonds, or other investment products will always increase.
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, MACRO recommends a consultation with a qualified tax advisor, CPA, financial planner, or investment manager.