Donor Advised Funds (DAFs) are a great tax planning tool for those who are charitably inclined. They are especially compelling when you have highly appreciated stock in a brokerage account or if your income is significantly higher than usual in any given year.
Understanding the Tax Advantage
Essentially, a Donor Advised Fund is a separate investment account for giving. It holds charitable contributions that haven’t yet been granted to specific charities. With a DAF, you can donate a large amount in one year to get a larger tax deduction but spread out the actual donations over several years.
For example, let’s say you plan to donate $10,000/ year to a qualified charity for the next five years and at the same time you have appreciated stock in a taxable account. You could donate $50,000 worth of stock to your DAF and grant $10,000 to the qualified charity over the next five years. In this example, you will receive a $50,000 charitable deduction this year (assuming it does not exceed AGI limitations). Not only will you receive this deduction, you also won’t need to pay taxes on the appreciation in the stock. You just reduced your taxes while donating the same amount you were planning to donate all along.
It is important to note that charitable deductions have AGI limitations that vary based on what’s being donated (cash vs. stock). Also, you must itemize to receive the tax benefit so donations should be large enough to count. However, this strategy can still make sense with donations that are far less than in the example used above. Lastly, please note that the example above doesn’t include the potential growth from your donations being invested.
Mechanics of a Donor Advised Fund
Contributions to a Donor Advised Fund are irrevocable and must be given to a qualified public charity. The DAF program sponsor (organization where the account is held) approves grants to ensure that donations are being made to qualified public charities. The key takeaway is to remember that this is technically not your money anymore – it belongs to a program sponsor who agrees to let you decide how the funds are donated (as long as you adhere to IRS guidelines). Even with oversight from the program sponsor, one of the notable advantages of a Donor Advised Fund is the flexibility it offers.
Once your DAF is funded, you can determine which qualified charities to grant the funds to, how much to give, and when. You can make these decisions immediately or over the course of several years. Program sponsors typically require at least one grant be made every few years but there isn’t a time limit for the distribution of funds. Schwab Charitable and Fidelity Charitable both have an excellent reputation for low costs and superb flexibility (ie. low contribution minimums, low grant minimums, etc).
If you think this strategy may be right for you, we encourage you to work with a Certified Financial Planner™ or CPA to better navigate the tax guidelines. Don’t hesitate to contact us with questions or to discuss this topic further. We enjoy helping clients save money in the process of giving to a good cause.
Please also check out our post on another charitable giving strategy!
Hannah Szarszewski is a Certified Financial Planner(TM) professional and Accredited Financial Counselor® practitioner who helps clients with retirement planning and other financial issues. To learn more about her background and the Keener Financial Planning approach, please visit the Interview Hannah page.