Are Donor Advised Funds for Me?

Dec 2021

December has arrived, which means the holiday season is here! In addition to shopping for family and friends, many of us are looking for ways to give charitably. While not as common as traditional check-writing, donor-advised funds are an excellent option for those who are looking for ways to give financially.

Let’s start with the basics: what is a donor advised fund?

A donor-advised fund is like a charitable investment account, established for the sole purpose of supporting organizations you care about. When you contribute cash, securities, or other assets to a donor-advised fund, you are generally eligible to take an immediate tax deduction equal to the fair market value of the contribution. Then, those funds can be invested for tax-free growth. Contributions to the donor-advised fund are irrevocable, which means you need to be confident that you won’t need the money or change your mind in the future.

The upside

Taxes: Donor-advised funds come with multiple tax advantages. Contributions of appreciated assets avoid capital gain taxes, while at the same time allow for a charitable deduction equal to the full fair market value of the contribution. For example, a stock (or mutual fund) with a cost basis of $25,000 but worth $40,000 that is contributed to a donor-advised fund counts as a $40,000 charitable contribution and the $15,000 of unrealized capital gain is not taxed.

Following the 2018 tax-law changes, which increased the amount of the standard deduction, most investors are no longer itemizing their deductions and therefore unable to deduct charitable donations for tax purposes. (There is a limited deduction in 2021 for non-itemizers). Donor-advised funds allow donors to make a larger contribution in a single year and take the itemized deduction up front, but still make smaller charitable contributions over time.

Donor-advised funds can be funded with cash as well as appreciated assets including stocks, bonds, mutual funds, privately held interests, restricted stocks and even cryptocurrencies. Cash qualifies for a deduction of up to 60% of adjusted gross income (AGI) and securities or other assets can take a deduction of up to 30%.

Control: Donors retain control over how assets are invested as well as when and where charitable donations are made. Donations can be distributed all at once or over time to as many charitable organizations as the donor wishes. The organization must be an IRS-qualified public charity with grant recommendations. The public charity sponsoring your account, such as Fidelity Charitable or Schwab Charitable, conducts due diligence to ensure the funds granted are used for charitable purposes.

Tax Free Growth: The charitable dollars in your donor-advised fund can be invested before they are granted. With market growth, your balance can also grow. This makes even more money available for grantmaking. Moreover, while you can take an immediate tax deduction for the gifts you make to your donor-advised fund, you will not be taxed on any growth, since the assets belong to the donor-advised fund’s charitable sponsor.

The downside

Irrevocable: As mentioned above, a contribution to a donor-advised fund is an irrevocable commitment to a charity. Funds cannot be returned to the donor or any other individual or used for any purpose other than grantmaking to charities. So, before contributing to a donor-advised fund, be sure you’re confident that you won’t need the money or change your mind on your philanthropic giving goals.

Minimum Donation Amounts: Grants made to charities are subject to minimum donations. Schwab and Fidelity require a minimum of $50, while Vanguard requires a minimum of $500 for each grant.

Limited Organizations: With a donor-advised fund, you generally cannot support organizations other than IRS-qualified, 501(c)(3) organizations, such as political groups or crowdfunding campaigns. Private foundations are also ineligible. Grants that may provide a personal benefit, such as a school tuition for a grandchild or tickets to a charity event you will attend, are also ineligible.

Donor-advised funds are easy to establish and can help you achieve your charitable goals in a tax-efficient manner. As always, each investors’ situation is unique. It is always recommended to speak to your financial advisor and tax professional to fully understand if donor-advised funds could be right for you.

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