What are donor-advised funds?

Donor-advised funds are democratizing philanthropy.

  • By Coryanne Hicks,
  • U.S. News & World Report
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Donor-advised funds (DAFs) are tax-advantaged investment accounts used for charitable giving. You can fund a DAF with cash or other assets and take a tax deduction for doing so. Usually people opt to contribute their appreciated investments so they don't have to face the tax consequences of selling it themselves. Once inside the donor-advised fund, your contributions continue to grow tax-free until you elect to issue a grant to the IRS-approved charity of your choice.

The beauty of donor-advised funds is they're available to anyone. "When people hear philanthropy they think they have to be Jeff Bezos to open this, and that's not the case," says Bill Van Sant, senior vice president and managing director at Girard. Donor-advised funds are "designed to be a simple, turnkey way to execute your philanthropic wishes, whether you're giving $500 or several million."

You can give as much or as little (as long as it's at least $50) as you want to one charity or dozens whenever you choose. It's for this reason that Van Sant calls donor-advised funds "flexible philanthropy."

Defining donor advised funds

"DAFs have grown in popularity because of their relative low cost and administrative burden," says Fran Seegull, executive director of the U.S. Impact Investing Alliance in New York City. "All accounting, administration and filings are conducted by the charitable sponsor of a DAF, making it the ideal option for those lacking the time, resources or inclination to start their own private foundation."

Seegull adds that there will be a fee for the DAF sponsor's services, but it's often less than the cost of managing a private foundation.

Unlike private foundations, setting up a donor-advised fund is as easy as opening a brokerage account. Like an IRA, you get to take a tax deduction for any contributions to the account, then watch the investments grow tax-free. Since they stay invested until you make a grant, you may have even more to give to your favorite cause than when you opened the account, says Jacqueline Valouch, head of philanthropy at Deutsche Bank Wealth Management in New York City.

While donors can advise on how they want their funds to be invested, it's important to know that ultimate control remains with the DAF sponsor. This can pose a drawback for some investors as your investment and giving options may be limited.

"Donors need to consider what they're looking to accomplish with their philanthropy, including how much control is important to them and how they expect to invest," Valouch says.

Since the account is intended for the benefit of charities, "most places will limit how wild you can get with your investments," Van Sant says. You won't be able to day trade or use exotic options inside a DAF account, for instance.

Most important of all is that any gift to a donor-advised fund is irrevocable. The only way money can leave your account is to a "bonafide 501(c)(3)," Van Sant says. "It can't go to your brother." (Unless your brother runs a 501(c)(3).) So "your intentions must be sincere" when you open a donor-advised fund.

How donor advised funds work

Step 1: Open your donor-advised fund account. You open a donor-advised fund account just as you would any other investment account. Most larger institutions like Fidelity Charitable and Schwab Charitable let you open them online.

You can have multiple account holders (typically up to four or five) and get to name your fund whatever you'd like. It could be Mr. and Mrs. Smith's Charitable Fund or you could name it after a cause you're trying to support. Really, the dictionary's the limit – or not if you're feeling creative.

At this stage, you'll also want to designate successors for your account. These are the people or charitable organizations who will take ownership after you pass away.

"DAFs are great vehicles for engaging and teaching the next-generation about charitable giving," Valouch says. But be aware that "some DAFs have restrictions on using the DAF in-perpetuity for multiple generations."

Step 2: Fund your DAF account and take a tax deduction. Most donor-advised funds require a $2,500 to $5,000 minimum initial contribution. But after that, there's typically no minimum account balance to maintain.

"Unlike private foundations, DAFs accept a broad range of asset types at varying sizes," Seegull says. You can donate cash or publicly-traded assets like stock, mutual funds, or bitcoin. Some accept private equity and even physical real estate. The only limitation (beyond what you own and are willing to part with) is what the sponsor will accept.

You get to take an immediate tax deduction for your contribution. For cash, you can deduct up to 60% of your adjusted gross income (AGI). For appreciated assets, you can deduct the full fair-market value up to 30% of your AGI.

Note that the sponsors will likely sell any contributed assets upon receipt so they can be invested elsewhere.

Step 3: Invest your contributions. As the donor, you advise how you want your donor-advised fund to be invested. Most offer stock or bond mutual funds and asset allocation funds. Some provide real estate and hedge funds, too. Larger accounts may have access to an individual investment advisor who can manage your account for you.

DAFs are also increasingly offering impact investing options, Seegull says. "In this way, the investment capital of a DAF account can deliver impact while the donor considers what charitable gifts to recommend."

Step 4: Give a grant. Generally, there is no time restriction on when you give. Make a grant tomorrow or wait several years; it's up to you. That said, many sponsors require at least one $50 grant be made every five-year period. If it is not, the sponsor may issue a grant on your behalf to keep the account active.

You can make one grant to a single charity or hundreds of grants to dozens of charities. The staff will often be able to assist you in making more sophisticated donations, such as international grants or scholarships, Seegull says.

You can put your name on the grant or remain anonymous to prevent yourself from getting hounded with solicitations afterwards.

Here again your sponsor will have the final say, however. While most larger organizations will allow grants to almost any 501(c)(3) public charity, some may impose their own moral limitations.

While rare, "some smaller foundations make it clear there are certain organizations they will not support," Van Sant says. "Once you take the tax deduction, you're giving up control." You can advise, but ultimate control remains with the sponsor. So choose wisely.

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