A donor-advised fund is a private fund established to manage charitable donations of individuals, couples, families and institutions and is in many ways similar to a private foundation. It is sponsored by a 501(c)(3) non-profit organization often through major custodians such as Fidelity or Schwab or through mutual fund companies such as Vanguard. There are also independent funds that can be used at any major custodian and avoid potential conflicts of interest of using proprietary products. Independent funds also permit the use of professional advisors to manage investments and may accept closely held company stock, real estate, and other less liquid assets.
The process of gifting through a donor-advised fund works like this. You open and fund an account with a donor-advised fund sponsor. You make an irrevocable contribution of cash, securities, or other assets to the fund and receive an immediate tax deduction.
While the fund has legal control over the irrevocable contribution you have made, you or your investment advisor advise the fund where the assets in your account should go and how they should be invested. The fund is the actual grant-maker that writes the checks to the charities and nonprofit groups you recommend. Making a grant is very much like using an online bill pay service that you would use through your checking account. The charity receives a check in the mail from the fund, “The John and Jane Jones Family Donor Advised Fund” for example. If privacy is a concern, full anonymity can also be elected when making a grant.
DAFs Offer Control With Flexibility
With donor-advised funds, you don’t have the hassles that come with running a private foundation, and you have the ability to advise that the fund make grants to the charities or nonprofits you think are worthy and are approved as a public charity as defined under 501(c)(3). The standard tax deduction for donations to a private foundation is 30% of a donor’s AGI. In a donor-advised fund, a donor can make additional cash donations up to 50% of AGI.
Besides the satisfaction of helping charities and the tax deduction, what also makes donor-advised funds attractive is what you don’t have to do. Since you aren’t creating a private foundation, you don’t have to establish tax-exempt status; you don’t have to form a board that will have fiduciary responsibility and schedule board meetings; you don’t have to pay out at least 5% of asset values for charitable purposes each year; you don’t have to pay set-up fees to attorneys and accountants; you don’t have to file discrete federal and state tax returns annually.
You may be able to open up an account in a donor-advised fund with as little as $5,000; minimums are usually in the neighborhood of $10,000-25,000. In contrast, it generally takes at least $1 million to start a private foundation. Fees to the sponsor are typically around 1% of the assets in the donor-advised fund.
Examples of DAFs In Action
First, suppose that you wanted to teach your children your values in regards to giving. A donor-advised fund is established and you plan to distribute five percent of the fund’s value each year to charities. Of that amount, you allocate $1,000 so that each of your children can participate in recommending grants. The children research causes that interest them and then meet with you to present their recommendations. You then help your children decide which charities the family fund will support. Having a family meeting such as this tied to Thanksgiving or the holiday season where the entire family can participate can be very profound.
Second, suppose you regularly give to charities. Also suppose that upon the advice of your wealth manager you are going to execute Roth IRA conversions in 2012 before income tax rates potentially rise in 2013. By accelerating your planned charitable contributions for the next few years into 2012 through the use of a donor-advised fund, you receive a full and immediate charitable deduction and can potentially fully offset the income tax on your Roth IRA conversions. You can also retain assets in the fund and make grants over the next few years as planned. Further, if you can make a gift of appreciated stock, not only do you receive a charitable deduction at the full market value of the stock, but you also avoid any capital gains tax on the stock forever.
Third, suppose you own a successful business. You establish a fund and contribute some of the closely held shares in your business to the fund. You could take an immediate income tax deduction on the fair market value of the shares contributed. Had you elected to establish a private foundation, your tax deduction would have been limited to your cost basis on the shares contributed. Also, because of annual limits on deductions as a percentage of adjusted gross income, you can take income tax deduction more quickly than if a private foundation was utilized. You could then sell the stock through the fund with no capital gains tax liability to the fund or to yourself.
If you are making or intend to make charitable contributions, these are just a few of many possible scenarios where using a donor advised fund can enhance your charitable and tax planning.
Kevin Kroskey, CFP®, MBA is President of True Wealth Design, an independent investment advisory and financial planning firm that assists individuals and businesses with their overall wealth management, including retirement planning, tax planning and investment management needs.