By Wesley Botto, CPA, Guest Writer
A Donor-Advised Fund (DAF) can be a powerful tool. Because of this, more people are becoming aware of the benefits. Many people ask, “Should I open a Donor Advised Fund?” This may seem like a simple yes or no question, however, there are multiple factors to consider.
Do You Have a History of Giving to Charity?
The first question that needs to be asked is: Are you already giving to charity? In my experience, if someone answers “No, but…” there might be a perfectly good reason why they aren’t giving to charity now. However, that does not mean that their first foray into charitable giving should be with a DAF.
Don't Rush into a DAF If You Are New
Unless there is a one-time event (such as the sale of a business or other taxable event), there should not be a rush to jump into a DAF. Potentially, if someone is nearing retirement, there might seem to be a rush. However, if there is not a history of charitable giving, it can cause problems. If there is not a history of charitable giving, it is less likely for the donor to understand the utility of a DAF. A DAF introduces some (but not a lot) of complexity that could be avoided by not jumping in before you know you are ready.
How to Start
For the person that does not have a history of charitable giving but would like to start, I suggest planning out your charitable gifts. Decide which charities you are passionate about. Get excited about making an impact with them. Give it a year and then re-evaluate to determine if you want to jump into the (slightly) deeper water of a DAF.
For the person that has a history of giving to charities, the next question is:
Why Are You Considering a DAF?
Everyone is always looking for a tax break (and rightfully so). In order to ensure you will actually get a tax break, you need to understand the situations when a DAF is beneficial:
You Will Make Lifetime Charitable Contributions
If you plan to make charitable contributions for your entire life, including the years when you are not working (thus have a lower income) a DAF is a great tool to maximize your deductions during your earning years. Assuming that the tax rates stay relatively similar to today (even with the TCJA sunset in 2025, the rates will not be too different), then you will likely have a much lower income in retirement, thus reducing the value of a charitable deduction. There’s a high likelihood that you won’t even itemize in retirement, which further increases the value of contributing to your DAF during working years. If you spent your working years building up a DAF, you will spend your retirement years making DAF distributions to your favorite charities, and they will not know the difference.
You Utilize a Bunching Strategy
The “bunching strategy”: this is where you give to a DAF in addition to making your normal annual gifts. It is important to do an analysis to make sure that this strategy is going to be worth the hassle. Here’s how you do it:
If you currently are not itemizing and you use the standard deduction, this could be a useful strategy.
If you are already itemizing, calculate your itemized deductions EXCLUDING the charitable deduction. This measures the impact that the bunching strategy will have. If the difference between your deductions less charitable contributions and the standard deduction is not significant, the bunching strategy will be a lot of hassle for little benefit.
For example, in 2019 the standard deduction is $12,200 for single filers and $24,400 for married filing joint. If your deductions excluding charitable gifts equal $23,000 (married filing joint), the bunching strategy will only give you an additional $1,400 in deductions – and it won’t be every year.
If you’ve done the above analyses and determined that the bunching strategy may still be of value, you should understand how a donor-advised fund works.
[Editor's Note: Note that bunching does not require a DAF. You can simply give two years worth of contributions to the charity at once. For example, you give your 2020 contribution and your 2021 contribution on January 2nd, 2021, take the standard deduction in 2020 and itemize your deductions in 2021. You only need the DAF if you want to take the deduction now but not give the charity the money until later, a move I have affectionately referred to in the past as the “jerk move.” Alternatively, you can donate “for 2020” on January 2nd, 2021 and “for 2021” on December 28, 2021. The donations are a year apart, but you get to take the deductions all on your 2021 taxes.]
How a Donor-Advised Fund Works
Donor-advised funds have become a popular alternative to charitable foundations. Charitable foundations have more red tape, required tax filings, and more hoops to jump through. Donor-advised funds offer many of the tax advantages of charitable foundations without the hassle.
Charitable Tax Deduction
When you contribute to a donor-advised fund, you receive a charitable deduction in that tax year (subject to charitable contribution limits). Keep in mind that once you make the contribution to a donor-advised fund, the money is no longer yours – the funds must eventually end up with a qualified charitable organization.
Contributions Can Be Invested
Another advantage of a donor-advised fund is that it allows you to invest the money within the DAF. This can put you in a position to have your own “charitable endowment.” For example, it could be a goal of yours to build up your DAF to $25,000. If you invest the fund in a manner where you can achieve an annual 4% rate of return (a modest and attainable goal) then you will be able to make gifts of $1,000 in perpetuity. The more you add to the DAF, the more you can give on an annual basis.
DAF Expenses
One of the pitfalls of a DAF is the expenses. The DAF will be held with an institution that charges an annual fee (typically taken out of the balance of the fund). You will want to take this into account.
Multi-Generational Legacy
One of the most exciting aspects of a DAF that I have not mentioned yet is how you can create a multi-generational legacy of giving with a DAF. If you continue to make gifts to your DAF and only disburse the growth, your DAF can last as long as you want. It will enable you to bring your kids into very fun conversations about making an impact on causes that are important to your family. That has the potential to instill generosity in them that can extend for many generations.
I hope that this article does not come across as recommending against using DAFs. I am a big proponent of them as part of a charitable giving strategy. DAF’s are a creative and fun tax and charitable planning tool to consider in your own strategy. However, it is important to go in with your eyes wide open and understand when it makes sense. It may be best to continue making gifts of appreciated stock, or cash in the short-term with a long-term goal of opening up a DAF.
What do you think? Do you use or are you considering a donor-advised fund for charitable giving? Why or why not? Comment below!
[Editor's Note: Wesley Botto, CPA, is a Partner and Financial Advisor at Hillcrest Financial Group. Hillcrest Financial Group is a paid advertiser and a WCI Recommended Financial Advisor however, this is not a sponsored post. They are currently offering a free consultation for any WCI reader that wants to explore whether or not a donor-advised fund is a good fit for them. This article was submitted and approved according to our Guest Post Policy. WCI has written before about DAFs, here and here.]
I’ve been using a DAF for years, and I love it. I did have a history of charitable giving beforehand, but I have found that we give more generously when the grants come for the DAF rather than our checkbook. I view that as a very good thing.
A note on taxes and fees: donating appreciated assets (like stocks, ETFs, or mutual funds with a low cost basis relative to present value) eliminates any potential capital gains taxes. You don’t pay them and neither does the recipient. Regarding the annual fee charged by the DAF (0.6% is common), your tax drag on assets held in a taxable brokerage account may be very similar, so I consider this more or less a wash.
Cheers!
-PoF
We just started using the DAF. Honestly it was largely because I was tired of having to wrangle a ton of receipts for taxes at the end of the year. Most of our donations went to our church, but there would be dozens of $100-$1000 donations to various other causes throughout the year. Now it’s just all our DAF.
Super convenient in that respect. I agree.
When I started my DAF a couple years ago, the impetus was to use it for “superbunching” charitable donations to maximize the deductibility of donations that I would have made anyway, given that the standard deduction was increased so much. I give away about $15K a year and don’t have many other deductions at this point, so I would get no tax benefit for the contribution as my total itemized deductions are well below the $24K married filing jointly standard deduction. Even bunching two years together wouldn’t be all that helpful, so I decided it would be better to take five years worth of contributions and put them in a DAF all at once so I could get a one-time deduction of $51K.
The other excellent benefit of the DAF is that you save a lot of time. My Schwab DAF makes the donation process much easier; all I need to do is look up the charity in their database, fill in a few spaces on one page on the site, and click on the donate button. Much easier than dealing with fifty or so donation requests, envelopes +/- stamps, and checks. It also saves effort at tax time since I don’t need to gather up all of the receipts like I used to, and I don’t have to fill in a couple extra pages on Schedule A for each donation I make. My wife is also happier since the main tax-related job I delegated to her every year was documenting all of the non-monetary contributions we made and determining their taxable value, a task that she really disliked. Since we aren’t itemizing deductions any more, that job has gone away completely.
That’s a great idea. Bunching can be more than every other year. It can be q5 years or whatever.
I started a DAF for two reasons: not having to dig up every single donation receipt come tax time, and to donate with name only (no address or contact info) to avoid all the mailings. I really like those benefits.
We just recently ended up creating a DAF solely to support the idea of giving as something we could spread to our readers. We combined the FIRE aspect (4% rule of thumb) as this article mentions and are giving our readers the ability to decide what charitable organization or non-profit should receive monthly donations.
Leif over at Physician On FIRE was a big help in planning the DAF along with your articles about it, WCI. Thanks!
This article does a great job of highlighting some reasons to be cautious about DAFs. I think it’s also important to consider CARES act effects on the deduction limits in a given year related to AGI as it might effect the decision for some folks if they want to kick things off with a large donation.
I don’t believe the CARES act limited anything regarding DAFs, although it did add a $300 deduction for charitable giving aside from itemized deductions.
There is a 30% of AGI deduction limit when donating appreciated assets, which is a number I keep a close eye on. When donating cash, the limit is 60%.
If you go over, you can carry forward the donated money / assets to future years.
Best,
-PoF
That $300 donation/deduction can’t run through a DAF. That’s the only DAF specific thing.
I used and enjoyed the ease of a Donor Advised Fund as well as some of the tax advantages especially when donating appreciated assets. I will finish out the money I have in the fund this year and am now at an age to use my Required Minimum Distributions for charitable donation.( I realize this year it is not required but I sent most of them in February). Depending on the size of your after tax accounts and the amounts they have appreciated you may decide whether using a DAF or a portion of your RMD gifted directly to charity in retirement makes better sense . Tax laws and tax brackets change but just mentioning this as in my situation the accountant recommends using the RMD rather then putting additional funds into a DAF. Obviously if the DAF is well funded during working years it may be a great source for charity for many years in retirement. Once in retirement if your DAF starts to run low and your non Roth IRA is the largest part of your retirement assets the RMD charitable direct donation may be the best choice.
Forgive my ignorance, but can you use a DAF for routine tithing to your church? For example, let’s say you give $1000 / month to your church. Can you donate $12,000 to a DAF in January, then allow it grow over the year and then donate the initial principal + any gains to the tithe at the end of the year (assuming the Church isn’t banking on your monthly contribution). If you plan on giving it anyway, why not let it appreciate over the course of a year. If every parishioner was able to give 5% more / year (assumed real rate of return) that would really move the needle. Of course, with investing comes risk, but if you commit to making up for any negative returns (unlikely over time) in any given year, the risk overall is low. The downside is the church doesn’t get the tithe for a year, but you could overcome that by double giving for 1 year to create an account for the next year while keeping up your regular tithe. Is my post call brain missing something?
Yes
Presumably because you feel like the church can do something good with it. Besides, the church could potentially invest it tax free where you can’t.
Worth mentioning too that there are plenty of smaller charities that are less equipped at handling the finances of receiving gifts of appreciated stock. I serve on a couple of local nonprofit boards and while any gift is appreciated, nothing beats cash and is much less work for our pro bono treasurer. Transferring the stocks to DAF and then having Fidelity Charitable cut the check makes it much easier.
We opened a DAF a couple of years ago. While we routinely gave to multiple charities prior to this, we have definitively increased our giving since opening the DAF. It makes is so incredibly simple, and you can have a repeating donation set up as well. An unexpected benefit this year has been when my income plummeted precipitously and we had to do a little belt-tightening. The DAF was already well funded, so we were able to not only maintain our prior level of giving, but increase it (given how many institutions and people were struggling), despite choosing to reduce spending in other areas for a while.
I donate a considerable amount to charities each year. My hesitation has been the expense ratios on the DAF being much higher. Should I not consider that when deciding? I would appreciate any thoughts.
Regarding the annual fee charged by the DAF (0.6% is common), your tax drag on assets held in a taxable brokerage account may be very similar, so I consider this more or less a wash.
See the section on Debunking Donor Advised Fund Myths: https://www.physicianonfire.com/quarter-million-in-daf/
Cheers!
-PoF
So I am in the beginning of a 1yr fellowship now. We donate 10% of our take-home income. And we are going for PSLF. I currently have $10k in a taxable investment account. With all that said, would a most-optimized approach be:
– Keep saving after-tax money into this account now
– Transfer it into a DAF 2022 (the first full calendar year I won’t be a fellow)
My reasons are:
– Marginal tax bracket is lower during fellowship, so 2020 and 20201 my calendar year income will be lower…I should pay the taxes now
– I want to lower my taxable income, thus decrease my PSLF payment, for the year(s) I expect it to be highest (or at least be paid at the highest marginal bracket.
Further complicating this is the fact that I may not always meet the standard deduction. So if I won’t…I should save that money and wait until I can donate a larger amount in a year to get over that standard deduction, right?
Remember that appreciated assets must be held for one year before being donated to a charity or you don’t get to take the deduction.
I assume you’re already maxing out tax deferred accounts and HSAs?
Bunching deductions may increase your charitable donation. Certainly making charitable contributions is not going to lower your income/lower your IDR payments/increase PSLF forgiveness if you’re taking the standard deduction.
I have a question: Is the appreciation of securities in a Donor Advised Fund taxable to the Donor Advised Fund?Thanks!
No.