Donor-Advised Funds: Benefits, Examples & More
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Summary:
Donor-advised funds (DAFs) are private philanthropic vehicles administered by third-party organizations, enabling individuals, families, and organizations to manage charitable donations efficiently. These funds offer numerous advantages, including tax benefits and flexibility in asset donations. However, they also face criticism for potentially holding assets indefinitely and helping the wealthy gain tax advantages. In this comprehensive article, we’ll delve deeper into what DAFs are, how they work, their types, investment options, pros, cons, and criticisms. We’ll also address frequently asked questions and provide key takeaways.
A donor-advised fund (DAF) is a private philanthropic fund managed by a third party to facilitate charitable giving on behalf of individuals, families, or organizations. DAFs serve as a centralized vehicle for managing and distributing charitable donations efficiently. They allow donors to recommend where and when their contributions should be distributed to eligible charitable causes.
How a donor-advised fund works
Donor-advised funds have gained popularity due to their ease of administration and the control they provide donors over charitable gifts. They streamline philanthropy by aggregating multiple donors and processing charitable transactions efficiently. In addition, DAFs offer substantial tax advantages, making them an attractive choice for donors.
Unlike private foundations, DAF holders can enjoy a federal income tax deduction of up to 60% of AGI for cash contributions and up to 30% of AGI for appreciated securities donations. Transferring assets like limited-partnership interests to DAFs can help donors avoid capital gains taxes and receive immediate fair market value tax deductions.
According to the National Philanthropic Trust’s 2021 Donor-Advised Fund Report, these funds have become an increasingly efficient method for donating to causes, with assets held in DAFs reaching $159.83 billion in 2020, a 9.9% increase from the previous year.
Types of donor-advised-fund sponsors
There are several types of sponsors offering donor-advised funds:
Community foundations
In 2020, approximately 1,000 community foundations sponsored DAFs. These organizations have been pioneers in the DAF space, offering alternatives to inefficient checkbook giving and the complexities of private foundations. Community foundations typically attract donors interested in supporting local causes and employ staff with in-depth knowledge of local charity initiatives.
National donor-advised-fund organizations
There were about 55 national donor-advised-fund organizations in 2020. Some of these are affiliated with for-profit financial services institutions, while others are independent. They provide a range of options for donors, making DAFs accessible to a broad audience.
Public foundations
Public foundations support national and international charities focusing on specific issues or geographic regions. They often have specialized expertise to help DAF holders find causes that align with their philanthropic goals. Some public charities, such as universities and hospitals, establish DAFs within their organizations to further their charitable missions.
Allowed investments
Many DAFs accept non-cash assets, including stocks, mutual funds, bonds, and other complex assets. Donating non-cash assets can lead to more significant write-offs, making it an attractive option for individuals and businesses.
Example of a donor-advised fund
One notable national organization, Fidelity Charitable, offers the Giving Account as its DAF. Donors can enjoy tax-deductible donations, no minimum balance requirement, and the ability to set up recurring donations to their preferred charities. Funds in the account grow tax-free until donors decide to distribute them. Fidelity Charitable also accepts various assets, including stocks, mutual funds, bonds, and even cryptocurrencies like Bitcoin.
Advantages and disadvantages of donor-advised funds
Donor-advised funds offer several advantages:
- Control over the account
- Opportunity for larger tax write-offs
- Ability to donate non-cash assets
- Immediate tax benefits
However, there are also disadvantages to consider:
- Lack of final say on which charities receive your donation
- Assets can remain in the fund indefinitely
- Fees and minimum donation requirements
- Donations are irrevocable
Criticisms of donor-advised funds
Some criticisms of DAFs revolve around their potential to serve as placeholders for money and assets, benefiting the wealthy in gaining tax advantages. Critics have referred to them as “philanthropic fracking” and accused them of “warehousing wealth.” Unlike private foundations, DAFs are not required to pay out a minimum percentage of their holdings annually, leading to concerns about assets being held indefinitely.
Donor-advised funds vs. private foundations
Private foundations and DAFs both serve as charitable-giving vehicles, but they differ in their tax laws and regulations. Private foundations face stricter regulations and have more administrative control over assets and grants. They can make grants to organizations beyond IRS-qualified, 501(c)(3) public charities. There are two types of private foundations: operating foundations, directly involved in charitable campaigns, and non-operating foundations, which provide grants to various charities.
How long can a donor-advised fund last?
While there are no specific tax laws stipulating how often a DAF must be active, many providers have their own guidelines. For example, Fidelity requires donors to make at least one gift of $50 every two years to keep their DAF active.
What happens to a donor-advised fund when you die?
After the death of the fund creator, there are two
choices: distribute the remaining funds to approved charities and close the account or name a successor who can manage the fund’s administrative decisions. Advisors often address this question when opening the account.
What is the charitable limit for a donor-advised fund?
The limit for deducting contributions to a DAF is 60% of your AGI. Contributions exceeding this amount cannot be written off.
Benefits of donor-advised funds
Donor-advised funds offer numerous benefits that make them an attractive option for individuals, families, and organizations looking to engage in philanthropy:
1. Tax efficiency
One of the primary advantages of donor-advised funds is their tax efficiency. Donors can enjoy a federal income tax deduction for their contributions, allowing them to reduce their taxable income significantly. The deduction can be as high as 60% of their adjusted gross income (AGI) for cash contributions, making it a valuable tool for tax planning.
Furthermore, when donors contribute appreciated securities like stocks or bonds to a DAF, they can avoid capital gains taxes on the appreciated value. This can result in substantial tax savings, especially for those with highly appreciated assets.
2. Flexibility in giving
Donor-advised funds provide donors with exceptional flexibility in how they give to charitable causes. Donors can recommend grants to qualified charities at their own pace and discretion. This flexibility allows donors to respond to immediate needs, support specific projects, or engage in long-term philanthropic strategies.
Additionally, donors can contribute a variety of assets beyond cash, including real estate, closely held stock, and even complex assets like cryptocurrency. This diversity of options enables donors to optimize their contributions while supporting causes they care about.
3. Streamlined administration
Compared to establishing and managing a private foundation, donor-advised funds offer streamlined administration. The third-party organization responsible for administering the DAF handles administrative tasks such as record-keeping, compliance, and disbursements. This relieves donors of the administrative burdens associated with private foundations, allowing them to focus on their philanthropic goals.
Types of donor-advised fund investments
Donor-advised funds accept a wide range of assets for contributions, giving donors the opportunity to maximize their impact. Here are some examples of assets that can be contributed to DAFs:
1. Appreciated securities
Appreciated securities, such as stocks and bonds, are commonly donated to donor-advised funds. When donors contribute these assets, they not only receive a tax deduction for the fair market value of the securities but also avoid capital gains taxes on the appreciation.
2. Real estate
Real estate properties, including residential and commercial properties, can be contributed to DAFs. Donors can benefit from a charitable deduction based on the appraised value of the property while supporting charitable causes.
3. Closely held business interests
Owners of closely held businesses can use donor-advised funds to donate business interests. This allows them to make a significant impact on philanthropy while potentially reducing their taxable income.
4. Complex assets
Some DAFs accept complex assets, such as private S- and C-corporation stock, limited partnership interests, and other non-publicly traded assets. These assets can offer unique opportunities for donors to support causes they are passionate about.
Donor-advised funds and legacy giving
Donor-advised funds can play a vital role in legacy giving, allowing individuals and families to extend their philanthropic impact beyond their lifetime. Here’s how it works:
1. Establishing a legacy plan
Donors can include provisions in their estate plans to transfer their donor-advised fund accounts to their chosen successors, such as children or trusted advisors. This ensures that the philanthropic legacy continues, and future generations can continue to make charitable recommendations.
2. Naming successors
Donors can name successors who will take on the responsibility of managing the DAF and recommending grants. Successors can honor the donor’s charitable intentions and continue to support causes that align with the family’s values.
By leveraging donor-advised funds in their legacy planning, donors can create a lasting impact on the charitable causes they hold dear, promoting a culture of giving within their families.
Conclusion
Donor-advised funds offer a flexible and efficient way to engage in philanthropy while enjoying tax benefits. They provide a centralized platform for managing charitable donations, accepting a wide range of assets, and democratizing philanthropy. However, it’s essential to understand their advantages and disadvantages and consider how they align with your charitable goals and financial situation.
Frequently Asked Questions
What are the tax advantages of Donor-Advised Funds (DAFs)?
DAFs offer significant tax advantages, allowing donors to enjoy a federal income tax deduction of up to 60% of their adjusted gross income (AGI) for cash contributions. Additionally, donors can receive up to a 30% AGI deduction for appreciated securities donations. This tax efficiency makes DAFs an attractive option for philanthropy.
Can I contribute non-cash assets to a Donor-Advised Fund?
Yes, many DAFs accept a wide range of non-cash assets, including stocks, mutual funds, bonds, real estate, closely held business interests, and even complex assets like private S- and C-corporation stock. Donating non-cash assets can lead to more significant write-offs and tax benefits.
What is the minimum contribution requirement for Donor-Advised Funds?
While the minimum contribution requirement can vary depending on the specific DAF provider, some DAFs accept contributions with relatively low minimums, such as $5,000. However, it’s essential to check with the specific DAF sponsor for their minimum contribution requirements.
How long can a Donor-Advised Fund (DAF) remain active?
There are no specific tax laws stipulating how often a DAF must be active. However, many DAF providers have their own guidelines. For example, Fidelity requires donors to make at least one gift of $50 every two years to keep their DAF active.
What happens to a Donor-Advised Fund (DAF) when the account holder passes away?
After the death of the DAF account holder, there are two options. The remaining funds can be distributed to approved charities, and the account can be closed. Alternatively, the account holder can name a successor who can manage the fund’s administrative decisions and continue the philanthropic legacy.
Can Donor-Advised Funds (DAFs) play a role in legacy giving?
Yes, DAFs can play a vital role in legacy giving. Donors can include provisions in their estate plans to transfer their DAF accounts to chosen successors, ensuring that their philanthropic legacy continues. This allows future generations to make charitable recommendations and support causes aligned with the family’s values.
Key takeaways
- Donor-advised funds are a versatile tool for philanthropy, offering tax benefits and flexibility.
- They come in different forms, including community foundations, national organizations, and public foundations.
- Donors can contribute various assets, and DAFs can hold funds indefinitely.
- While they offer control and tax advantages, DAFs also face criticism for potential misuse.
- Understanding the advantages and disadvantages is crucial when considering DAFs for charitable giving.
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