Donor-advised funds (DAF) are investment vehicles administered by charities. Similar to a mutual fund or any other pooled investment, a donor-advised fund can invest in many different asset classes, using the funds from various participants.
The main difference is that all proceeds are intended to be donated to a public charity, just as a foundation or endowment would do. However, unlike a foundation or endowment, donor-advised funds are much easier to contribute to and some only have a minimum donation requirement of $5,000 to participate.
Investors, especially those in high tax brackets, should be familiar with donor-advised funds. When an individual contributes money into a donor-advised fund, they immediately get a tax deduction, just as if they contributed directly to a charity. However, one benefit of DAF is that they control the payout to the charity of their choice. The fund invests the proceeds and the original contributor can dictate when, where and how much can be donated. With a new tax bill that limits personal tax exemptions, many high-income individuals will need to find other ways to reduce their personal tax liability.
For information on the taxation of mutual funds, take a look at our article on How Mutual Funds Are Taxed.
Donor-Advised Fund Examples
Donor-advised funds have been growing in popularity and have actually become larger than private foundations. As of 2016, there were 285,000 donor-advised funds in the U.S., totaling over $85 billion in total charitable assets. In 2016, total charitable contributions totaled over $390 billion, of which only $23 billion was contributed to donor-advised funds. Although donor-advised funds only represent a small portion of overall charitable contributions, they’re popularity is increasing as shown by an 8.3% growth in 2016.
The largest donor-advised fund in the country is Fidelity Charitable, which as of June 30, 2016, had over $16 billion in net assets and over 82,000 giving accounts. During the fiscal year, the fund received over $4.07 billion in donor contributions while also distributing $3.19 billion to charitable organizations. Over 30% of the donations made were to charities specific to children and families, followed by 28% in international development and 21% in food distribution.
Fidelity makes it very easy for potential donors to contribute to the fund, with the minimum donation of $5,000. The Fidelity Charitable fund allows its donors to grant as little as $50 to almost any 501©(3) public charity of their choosing. There are also several different investment options, like asset allocation pools and single asset classes that invest directly in an index or even impact investing pools.
There are several other donor-advised funds, like Schwab Charitable, Vanguard Charitable or TIAA Charitable. Each of these funds has its own set of minimums and investment selections.
Advantages of a Donor-Advised Fund
The first immediate benefit of contributing to a donor-advised fund is the tax deduction. This is treated just as though the individual had contributed directly to a charity. In the case of Fidelity, individual taxpayers are able to donate up to 60% of their adjusted gross income if they use cash.
Another benefit to a DAF is that it allows donors to distribute their donations to wherever and whenever they choose. For example, if someone donates just prior to year-end, they do not have to pick a random charity. They can donate to a donor-advised fund and then take the time to select one or several charities whenever they want. Also, the donor does not necessarily have to transfer the entire donation to the charities that year. They can donate as often as they like, or not donate at all and just pass it on to their heirs for their donation purposes. Either way, a donor will immediately get the tax savings. The portion that is not granted to charity will remain invested and growing with the stock market, increasing the donation potential for the future.
For investors with taxable assets with a low-cost basis should also be aware of donor-advised funds. Typically a long-term holding will incur a 15% or 20% capital gain if sold. So for example, if an investor paid $10,000 for a stock which then grew to $30,000, they would be responsible to pay for the capital gain on the $20,000 profit. That would be equal to either $3,000 or $4,000, depending on their tax bracket. If the investor donated this stock to a donor-advised fund, they would claim a tax deduction on the entire $30,000 position without having to pay any capital gains tax. Individuals can donate up to 30% of their adjusted gross income worth of appreciated stock. Some donor-advised funds even let you donate other investments, like mutual funds, bonds, privately held business interests, life insurance, real estate and even Bitcoin.
Finally, contributing to a donor-advised fund makes charitable reporting a little easier, since all of the donations go to only one fund. This would be much easier for individuals who contribute to several charities, needing only one receipt from the fund instead of one from each charity.
Disadvantages of a Donor-Advised Fund
Although donor-advised funds are charitable in nature, many believe that there are several drawbacks to charitable contributions going to these funds. One is that there are administrative and investment management fees associated with these funds, which eventually eat away at any contributions. The Fidelity Charitable fund had over $74 million in operating expenses, even though it distributed over $3.19 billion to charities.
Another drawback that critics have voiced against these funds is that the contributions have no limit on when they will be paid out. Technically, a donor can keep their original contributions in a donor-advised fund for perpetuity and pass it on from generation to generation. The original contribution was granted the tax deduction, but no actual funds were donated.
Another issue with donor-advised funds is that the original contributor loses control of their funds once it is donated to the fund, and they may not like the investment selections that the fund offers. Also, once the proceeds are donated, the decision is irrevocable.
The Bottom Line
Overall, donor-advised funds have their advantages and disadvantages. For individuals looking for a way to donate highly appreciated taxable assets should consider donor-advised funds as a way to help diversify their portfolio and reduce their tax liability without having to incur capital gains. Donors also looking to give to various charities or give to charities over time should also look into using a donor-advised fund.
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