Charitable giving is a priority for many individuals, but maximizing its financial impact can take time and effort. One strategy worth exploring for high-net-worth individuals is the donor-advised fund (DAF), a philanthropic tool that offers flexibility and significant tax benefits.
Whether you've experienced a high-income year or are planning long-term charitable commitments, a DAF could help optimize your giving. How does a DAF work, and is it the right choice for you?
Technically speaking, a DAF is a charitable giving vehicle maintained by a registered 501(c)(3), or non-profit, organization. The organization manages charitable donations from the DAF for individuals, families, and other groups. In simpler terms, it functions like a philanthropic savings account but with significant tax benefits.
When you contribute cash, securities, real estate, or other financial assets to a DAF, you can direct those contributions to a charity or invest them tax-free and donate later. Best of all, you'll receive an immediate tax deduction upon contributing to the DAF, even if you don't donate those funds to an outside charitable organization right away. This is especially beneficial if you've had a high-income year and want to reduce your taxable income, like after receiving a windfall from inheritance or funds from a business or property sale. This gives you time to research non-profit organizations and consider your giving options while lowering your tax bill.
Understanding how a DAF works is crucial if you are considering adding one to your charitable giving strategy. Here is the three-step process involved:
You can contribute cash, securities, and other approved assets to the DAF. Once you do, you get an immediate tax deduction for the amount contributed, subject to IRS limits. According to our co-founders and Money Matters co-hosts Scott Hanson and Pat McClain, you can typically deduct 50% of your adjusted gross income for cash donations and up to 30% for appreciated securities.
Once contributed to the fund, your money can be invested and grow tax-free, enhancing your charitable impact over time. As Pat highlights in a recent podcast episode, "Once it's in that account, it can sit there forever." Without minimum distribution requirements, this growth allows for potentially more significant future donations, giving you more flexibility and maximizing the value of your contributions.
When you're ready to support a cause, you can recommend grants from your DAF to qualified charitable organizations. As Pat explains to a caller, "You get to direct it to what charities you want over as many years as you want. And I've got to tell you, once you've done this, you will not give to charities in any other way." This flexibility allows you to time your contributions to align with your charitable goals.
When you add a DAF to your charitable giving strategy, there are eight key advantages:
When you contribute to a DAF, you receive an immediate tax deduction for the total amount, even if you distribute the funds to charities over time. This benefits high-income years, as you can reduce your taxable income while deciding which organizations to support later.
Contributions to a DAF can be invested, allowing them to grow tax-free. This growth means your charitable dollars can flourish, allowing you to give more than initially intended.
Sometimes called "the waiting room for charitable donations," a DAF offers flexibility in timing your donations. You can recommend grants to your preferred charities at any point, allowing you to plan your giving strategically without added time pressure.
With a DAF, you can consolidate multiple charitable donations into one account, simplifying your recordkeeping and making tax reporting easier. Instead of tracking every donation to different charitable organizations, you only need to track your contributions to the DAF.
A DAF allows you to donate appreciated assets, such as stocks, bonds, or real estate, avoiding capital gains taxes. This reduces your tax liability and can make a more significant charitable contribution based on the asset's current market value.
You can make anonymous donations through a DAF if you prefer to give privately. This can be particularly beneficial if you do not want to disclose your name or the amounts you donate to charitable organizations of your choosing.
A DAF can engage family members in charitable giving. You can involve your children or grandchildren in recommending grants and even designate heirs to manage the fund after your passing, creating a legacy through future charitable donations.
A DAF provides the benefits of a private foundation, such as long-term charitable giving, with lower startup and management costs. This makes them attractive if you desire a more straightforward, cost-effective charitable giving strategy.
While a DAF can be an excellent philanthropic vehicle, there are certain limitations to keep in mind:
While donor-advised funds are generally more cost-effective than a private foundation, they can include annual administrative, maintenance, and investment fees. Before contributing to a DAF, it's essential to know what fees are charged and if there are any minimum donation requirements.
While a DAF offers flexibility in recommending where your donations go, the sponsoring organization must approve all grant recommendations. This loss of control can be a drawback if you prefer more oversight of your charitable funds.
Since the tax benefits of contributing to a DAF are immediate, contributions are irrevocable, meaning they are committed to charitable purposes once you have donated. Regardless of changes in your finances, the funds are no longer available for personal use.
A DAF provides a streamlined, flexible approach to charitable giving, combining immediate tax advantages with growth potential. Whether you're looking to simplify your charitable contributions, create a flexible philanthropic legacy, or donate privately, a DAF could be right for you.
For personalized advice on whether a DAF aligns with your goals, speak with an Allworth Financial advisor to learn more.