• By Katie Zame
• Posted October 21, 2022

What is a Donor Advised Fund?

A Donor Advised Fund (DAF) is an account to accumulate invested savings for personally directed charitable donations without restrictions on establishing a foundation with annual distribution requirements. A DAF can be set up by an individual or a family using a company like Schwab Charitable, Fidelity Charitable, or local community foundations where a donor can continue to invest their savings for charity prior to gifting to their intended charity. Our certified financial planners help clients with charitable donation planning.

Why are DAFs useful?

Donor Advised Funds are, by IRS code, individual charities themselves. Once a donor moves money into that account, the donor is eligible to report the gift within their annual tax records, regardless of when the gift to an intended charity (grant) is made. When granting money to the intended charity, there is no tax impact on the individual, as the gift has already been made. Any growth within the account from investment activity can be passed on to charity with no taxes.

The number of contributions to be made by a donor is always up to the donor. I’ve worked with people who give their annual amount to a donor-advised fund that they use throughout the year for their regular giving. I’ve also worked with people who move about five years of their regular giving into their charitable account at a time. The minimum amount to contribute to a DAF is dependent on the terms of the company that holds the account, but I’ve seen minimums of $25. There are also minimums for grants, but they too can be manageably small at a similar $25 per grant. When a grant is made, the DAF account writes a check to a charity, providing an easy cash gift that will be immediately available for use.

Because the account can most often be invested with options similar to a 401k or 403b retirement account, the DAF has the potential to both grow or lose money depending on the changes in the market. Investing carries risk. If you plan to spend from the full balance each year, you may choose a more conservative investment option to safeguard what you put in the account. When the account has time to grow between contributions and distributions, you have the potential to be able to give more than you originally saved. Investment gains are never taxed, as the account operates as a charity. TenPath Financial Group in Hartford, Connecticut provides certified financial tax planning services.

First and foremost, a DAF is a charity account. Ideally, someone would have charitable intent to give to organizations that matter to them. Individuals who use DAFs would benefit from understanding their own personal philanthropic goals when setting up an account to make sure the account is put to good use.

What should a philanthropist at any level consider before setting up a DAF?

One reason for younger people or people without a lot of savings to open a DAF may simply be to help with personal mental accounting and cash flow planning. Monthly giving enables savings-restricted donors the ability to make more impactful annual gifts. Here are a few reasons why establishing a monthly giving plan to a donor-advised fund may be helpful:

• You want to minimize the impact of your annual giving on your own bank account
• You want to reduce the impact of monthly fees your preferred charity has to pay to run your credit card
• You want to reduce the amount of exchange losses that your local organization will have to pay when giving to an international organization (from currency discrepancies and international exchange fees)
• You want to give a more significant gift for special giving campaigns

A DAF can act as regular annual giving or as a charity emergency fund, where money is set aside for those times of crisis or joy that you want to support in a one-time gift.

People that are more established in their careers, and who have taxable savings accounts or stock incentive plans use more complex tax planning that can be enhanced by the use of a Donor Advised Fund. These individuals can gift stock from a taxable account that is highly appreciated (or has grown over the years). If the investor were to sell the stock themselves, they could create a significant taxable income that may not be desirable. Not every charity accepts stock gifts and those that do may not accept what the donor wishes to gift. Companies such as Schwab Charitable or Fidelity Charitable allow donors to gift stock directly to the donor-advised fund through a transfer of assets. Once the fund receives the stock it’s sold with no tax impact to the donor.

This is helpful for people who have large positions in a stock holding that creates an overbalance of one investment or asset class in their investment portfolio. It also essentially turns illiquid assets (especially because of the tax consequences of the sale) into cash that can be distributed for charitable giving over time. Redirecting the security to a DAF makes the funds immediately available to gift to a charity or to save for future intended grants. It also gives the opportunity to lessen the weight of that individual security on their investment portfolio without a taxable sale.

For people with irregular income streams, such as business owners and consultants, a high-income year may also have a high tax impact. A DAF can be used in years when people are increasing their income for other reasons too, including an unexpected bonus, severance or retirement package, a company selloff, and an IRA withdrawal for a large purchase or Roth conversion. Any of these changes can shift someone’s tax bracket for one or a few years and can be controlled when using charitable giving as an income-smoothing strategy.

A DAF may be a good tool for someone to use to collect several years of their intended charitable giving into an account that would benefit them in that year. The idea of “bunching” giving in years of higher income help people itemize their tax deductions when they may not always be able to do so. If a donor is not usually eligible to use itemization, it may make sense to contribute several years of annual giving to a DAF in order to itemize in some years.

Some other elements of how to use a DAF

DAFs can have a successor beneficiary or a successor director so that you can identify who should receive or direct the funds when the original donor is longer living. Successor donors are never owners of the account and can never move money from the charity to themselves, but they will be able to continue making grants to organizations of their choice. If a DAF does not have a successor beneficiary, successor charity beneficiary, or successor donor, the funds are often left for the company that established the fund to determine how to use the funds. Learn more about TenPath Financial Group's succession planning services here.

To be clear, we don’t recommend leaving an account without a beneficiary or successor director. Who knows what value directors at the charitable fund have, that may not fit your personal values or your choices? We much prefer that your values are reflected in the money that you saved over your lifetime. So instead of letting it sit in an account, we highly recommend that you make a plan for your charitable giving so that you are able to share what you’ve saved with the communities that you care about.

Charities are also vetted by the DAF company to make sure you are gifting to an official charity in good standing. If they don’t have your charity on file, you will need to provide the tax id number of the charity for the DAF provider to do a quick search before sending out your grant. As long as they are in good standing, the grant should be able to be made.

When looking into DAFs run by community foundations, a donor should review the rules on granting. Some will restrict eligible grants to a specific region or cause. If you want more flexibility within your gifting, it may make more sense to use a company like Fidelity Charitable or Schwab Charitable. Community foundations don’t always restrict grantee organizations. Just be clear from the beginning about what your intentions are and what their granting rules are. If you do support your local community foundation, they might be the perfect fit for you to leave as a beneficiary organization once you are gone, knowing that they will make use of your remaining funds in the community that you cared about.

From a charity’s perspective, they rely on regular and consistent giving to predict their upcoming budget and meet their financial obligations through unrestricted funds. It may be worth checking with your favorite organization how they prefer to receive your annual gifts, no matter when they send out their annual appeal letters. Remember that most charities get their greatest contributions in December, and they need to stretch those gifts out throughout the year for their operating budget. Gifting to your DAF in December can still allow you to give throughout the year or at a different time to allow your favorite charity more cash flow for its operating budget.

The best way to use a Donor Advised Fund is to use it; not only to fund the DAF but to direct the savings towards charity, ideally during your lifetime. If you would like to review your charitable goals and how best to meet them, consider working with a financial planner who is focused on community engagement and charitable giving. Some advisors will have a certification in philanthropy (the specific designation is the CAP® or Certified Advisor in Philanthropy®) to help assist clients in their charitable goals and will happily create a plan to help you see what you can do with your resources.

Contact Tenpath Financial Group for certified financial planning services.