What is a Donor-Advised Fund and How Does it Work?

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Paul Sundin, CPA

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A donor-advised fund is an investment account dedicated to charity. Donors realize many benefits including tax deductions, ease of record-keeping, and the ability to regularly contribute to their favorite charity.

Here’s everything you need to know about the donor-advised fund.

What is a Donor-Advised Fund?

A donor-advised fund is an investment in charity. You don’t have to pick a specific charity when you open the fund. You contribute the funds to your account, take the tax deduction, and let the money grow tax-free.

You can give your funds to any IRS-qualified charity, just like you could give them cash or donate with a credit card. With a DAF, though, you’ll get immediate (and sometimes higher) tax deductions, your money can grow for more contributions, and you can have all your records in one place for easy tax filing.

How the Donor-Advised Fund Works

To use a donor-advised fund, you must open an account at a brokerage, such as Fidelity or Charles Schwab. Read the fine print and understand the administrative and investment expenses before choosing.

Once you have an account, make contributions via cash, stocks, or other non-public assets. The donations you make to the fund are irrevocable, meaning you can’t change your mind and withdraw the funds later. Make sure you’re certain about the amount you’re contributing and put them in the fund.

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You don’t have to donate the money or assets right away – the funds can sit in your DAF and grow tax-free. This allows you to give more money to the charities of your choice, assuming the assets grow (there’s always a risk depending on how you invest).

When you’re ready to donate, you recommend a grant to your charity of choice, and they receive the donation.

What Happens to a DAF after you Die?

Your DAF can be a part of your legacy planning. You can include it in your will, requesting the sponsor to distribute the funds on your behalf. This does two things:

  • Ensures your money goes to the charities of your choice
  • Eliminates the estate tax your heirs may face if your estate is larger than the current tax-exempt limit

If you choose, you can create a plan that passes your DAF down to your heirs or to nominate one person to handle it for you. If you don’t recommend someone to take over the plan, your DAF sponsor (such as Fidelity or Schwab) will donate the funds according to the agreement you signed when you opened the account.

The Benefits of the Donor-Advised Fund

Donor-advised funds offer a variety of benefits, making your money go further while providing you with higher tax deductions, leaving more money in your pocket too.

  • Immediate tax deduction

As soon as you contribute funds to your DAF, you earn a tax deduction. This is similar to if you made a cash contribution, but you may realize more benefits if you donate long-term appreciated assets.

You can deduct up to 60% of your adjusted gross income from cash donations and up to 30% of your adjusted gross income from long-term appreciated asset donations.

  • Contribute a variety of assets

You can contribute more than cash, but even contributing cash from a DAF is easier than making straight cash donations. Possible contributions include:

  • Cash equivalents
    • Publicly traded stocks
    • Cryptocurrency
    • Private equity
  • The assets can grow tax-free

Any money you contribute to your DAF can sit as long as you want. There aren’t any restrictions regarding how much or when you must donate the funds. This allows the funds the chance to grow, furthering your contributions without taking more cash out of your pocket.

  • Simple record-keeping

Donating to charities yourself and keeping receipts gets overwhelming and confusing. With a DAF, you log into your dashboard at tax time and see exactly what you contributed and can deduct.

  • Option to be anonymous

You can choose to be acknowledged in your contributions or remain anonymous. While most donors want to be acknowledged, around 10% don’t – the choice is yours.

Why Choose a Donor-Advised Fund?

We discussed the benefits of a DAF, but why should you consider it over just donating regularly to charity?

The main reason is your ability to give more money over time. You can contribute funds today, take the tax deduction, and let the money grow. You don’t have to contribute the money to the charity today, but instead, contribute it to the fund, deciding when you want to contribute whether it’s this year, next year, or 10 years later.

Decreasing your tax liability today while ensuring you give to your charities of choice through the years is a good use of your money.

Watch the Fees

Before you choose a donor-advised fund, make sure you know the fees. They typically charge two types of fees:

  • Administrative fees – These are often a flat fee, or a percentage of assets invested. These funds cover the cost of managing the account for you. Most DAFs have administrative fees, but the amount varies.
  • Investment fees – Just like any investment account, there are fees for investing in different assets. Know the amount and how it will affect the money you have to contribute. While you’ll almost always pay investment fees, it pays to keep them low.

Bottom Line

If you want to use some of your money to give to charity, using a DAF is a tax-friendly way to do so, while maiming the amount you give.

As long as you choose IRS-approved charities and realize you can’t take back the funds you contribute, it can be a great way to maximize your contributions and decrease your tax liability, and/or limit your estate taxes.

There are many options to open a donor-advised fund. Shop around and find the account with the lowest fees and the most options when choosing investments to further your ability to give to charity.

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Estate CPA

Gilbert, AZ