Donor-advised funds: A way to give to charity and get a tax break
Donor-advised funds (DAF) have surged in popularity over the past few years, according to data compiled by Giving USA. These vehicles allow people to receive an immediate charitable tax deduction while spreading their donations out over time.
Are you a philanthropically minded individual interested in learning more? There are pros and cons to opening a DAF.
Key Points
- Donor-advised funds have been around for decades, but gained in popularity after tax code changes in 2017.
- The funds are invested by managers so your unallocated assets can grow over time.
- Contributions are irrevocable, so don’t put in more than you can afford.
What is a donor-advised fund?
A DAF is an account established to support 501(c)(3) charities recognized by the Internal Revenue Service. These funds allow donors to make a charitable contribution, receive an immediate tax deduction, and then recommend grants from the fund over time, according to National Philanthropic Trust.
Jonathan Raymon, a charitable solutions strategist for Baird Trust, says the funds themselves are charities, which is why donor-advised fund tax deductions occur immediately.
“When a contribution is made to a donor-advised fund, it is given directly to a charity. So you get the full benefit of a charitable deduction as if you were giving it to a public charity,” he says.
The only distinction between a donor-advised fund and other 501(c)(3) public charities is that donors cannot put qualified charitable distributions (QCDs) from their individual retirement accounts into a donor-advised fund, Raymon pointed out. QCDs can be gifted directly to other charities.
Some of the biggest donor-advised funds are managed by Fidelity Charitable and National Philanthropic Trust, he says.
How donor-advised funds work
The first purpose of donating is to be charitable, but donor-advised funds are a tax play, which makes them different from simply donating cash to a nonprofit organization, says Kristina Mello, senior financial advisor and director of financial planning for StrategicPoint Investment Advisors.
Giving USA says DAFs are one of the fastest-growing forms of charitable giving. These funds have been around since the 1990s, but the 2017 tax code changes sparked donor interest.
Because the 2017 tax code change hiked the standard income tax deduction—about $26,000 in 2023 for a married couple filing jointly—it’s now harder for taxpayers to use charitable deductions to itemize their annual tax reporting. That led to some people “bunching” deductions, meaning they would pool several years’ worth of giving into one year to get over the standard deduction tax threshold, allowing them to itemize their tax deductions that year. But that strategy can create a “feast or famine” scenario for nonprofit organizations—flush with donations one year, but receiving nothing in subsequent years.
Donor-advised funds help solve that problem.
“You get the tax deduction up front, but then you can subsequently issue checks or grants to charities for years to come,” Mello says.
Why open a donor-advised fund?
The primary point of opening a fund is to take advantage of the tax benefit in a year when you can itemize deductions. Mello says it’s also a way to organize charitable giving, since all the donor’s receipts are in one place.
“It creates a nice history over time and lets you make a chart to get a picture of where your priorities are,” she says.
Raymon says that because the funds allow donors to build up gifts over time, money can be spent when the need arises, and in large chunks.
The funds are also easy to open. Unlike traditional charitable trusts, these vehicles don’t require that you consult a tax professional or attorney to fill out paperwork.
What can I contribute?
The funds accept a wide variety of assets. Donor-advised funds are a great way to gift low-basis securities—that is, securities that have greatly appreciated in value since the time of purchase—to avoid paying capital gains taxes.
For example, Fidelity Charitable says acceptable gifts include:
- Cash or cash equivalents
- Marketable securities such as stocks, bonds, mutual funds, or exchange-traded funds
- Private equity and hedge fund interests
- Bitcoin and other cryptocurrencies
- Private company stock
- Real estate
- Life insurance
If you choose to donate cash, you can typically deduct up to 60% of your adjusted gross income (AGI). The IRS has a list of “50% limit organizations” such as churches, hospitals, and other organizations; you can only deduct up to 50% of your AGI for non-cash donations to these groups. Other specific assets may be donated up to 30% or 20% of your AGI.
If your donation exceeds your AGI limit, you can carry forward the extra deduction, Mello says.
Upon receiving the donation, the fund’s administrator will typically sell the non-cash asset and put the money into a mutual fund for diversification, and hopefully, tax-free investment growth. Because the money is invested in the market, your fund balance will fluctuate.
Fees and irrevocable gifts
Gifts made to donor-advised funds are irrevocable, so once those assets are donated, you can’t get them back, even if the money is still in the account. Mello says she works with clients to figure out the optimal gift amount to maximize their tax efficiency, but without giving so much money that it affects their lifestyle.
“You want to be careful that you’re donating within a limit that your budget can allow. It’s great if you’re saving on taxes, but not if it’s jeopardizing your retirement,” she says.
Funds must be donated to IRS-approved 501(c)(3) charities, and money cannot be given as gifts to individuals, political groups, crowdfunding campaigns, or private foundations.
Donor-advised funds have some costs, Raymon says, and the fees the organizations charge to administer and manage the fund’s investments can vary. For example, Fidelity Charitable fees are about 1% of the fund’s balance, which it says is less than the operating costs of a private foundation or credit card fees.
Donor-advised funds may not be right for people who aren’t bunching deductions or are immediately giving their money to charity every year versus letting the money in the account grow, Raymon says.
The bottom line
Donor-advised funds allow charitable individuals to support organizations they love and get a tax benefit—not an easy maneuver since the 2017 tax law doubled the standard deduction. There are a few rules donors need to follow, and donations are irrevocable—but these accounts are one of the most flexible charitable vehicles available.
Specific companies and funds are mentioned in this article for educational purposes only and not as an endorsement.