What is a Donor-Advised Fund (DAF)?
Contributing to donor-advised funds is a great way to lower your tax burden and support organizations aligned with your goals and values. Understanding how to effectively make use of these funds can yield major benefits when tax time comes around.
Key Takeaways
- Donor-advised funds, or DAFs, are a type of fund that allows donors to contribute assets immediately and determine how they’ll be distributed later.
- These funds can be created for individuals, families or even larger groups like community associations and civic groups.
- Making contributions to a DAF can provide big tax benefits, as contributions can be tax-deductible in the year they’re made rather than the year they’re distributed.
Donor-Advised Funds – What Are They?
A donor-advised fund is a tool for making charitable donations to specified nonprofits, as outlined by an advisor or board. These funds provide immediate tax benefits and are a great way to support groups and causes you care about while improving your tax position.
DAFs are operated by a third party and can be used by individuals or groups of individuals, including family units and community organizations. Contributions to the DAF can be made in the form of cash or other assets like stocks, real estate, personal property or cryptocurrency.
How a Donor-Advised Fund Operates
A DAF can be thought of as a sort of “charity bucket,” in which funds and other assets can be placed for later distribution to charitable organizations. The process is relatively simple:
- An individual or group donates assets to the DAF, realizing a potential tax write-off for the tax year in which the contribution is made.
- A third party manages the contribution along with all past contributions made to the fund, investing some or all of the assets at their discretion.
- At regular intervals or on an as-needed basis, funds are distributed from the DAF to charities selected by the donors or their designated advisors.
Benefits of Donor-Advised Funds
There are many benefits to including contributions to a DAF as part of your financial planning.
Tax benefits of charitable giving
Charitable donations in general can be a very useful tool in managing your tax liability each year. Funds and other assets donated to charity reduce your taxable income for the year while still yielding direct benefits to donors by way of the charities’ missions. By funding qualifying organizations aligned with your values and interests, you can reduce your tax burden and still see direct, measurable results from your contributions.
Donate now, decide later
Sometimes the best timing for a charitable donation doesn’t align with the best timing for improving your tax position. An organization may need funding further down the road, or you may not be totally certain which organizations you want your DAF to support. By contributing funds early, you can realize the tax benefits, and your donations will grow tax-free while you decide how to spend them.
Avoiding capital gains tax
When stocks or other assets are sold, you’re typically required to pay a tax on the amount the assets have appreciated over the time you’ve owned them—this is known as a capital gains tax. If you were to make a donation directly to a charity, you might need to sell some stocks, pay the capital gains tax on the sale, then contribute what’s left over to the nonprofit. Instead, you can donate the stocks themselves to the DAF and allow them to continue to accumulate value without worrying about the tax implications of the sale.
Challenges of Donor-Advised Funds
While a DAF confers many advantages to its donors, there are some important considerations to keep in mind before making any contributions.
No refunds
Once assets have been contributed to a DAF, they no longer belong to the original owner. Unlike some retirement tools with similar tax benefits, there is no way to withdraw funds early with a penalty or otherwise recover the assets. Once they’re gone, they must be donated to a charity.
Final say in donations
DAFs are set up to serve the interests of their donors, and generally speaking, the goals and values of the donors will be the primary factor in how money is distributed. Legally speaking, though, donors do not have the authority to distribute funds at their discretion. They are simply allowed to advise the fund managers on how the assets should be used.
Because of this, it’s absolutely critical to choose carefully when selecting a DAF manager. If you have questions about choosing a DAF, Horizons Wealth has a team of financial advisors that can answer any questions.
Fees and minimum contributions
Depending on the size and structure of your DAF management group, you may be on the hook for some modest administrative fees associated with the management of the account. Whatever administrative costs are associated with managing the fund are taken out of the contributions, reducing your overall impact.
You may also find that certain DAFs require a significant minimum contribution, especially when starting a new fund. This threshold contribution may be a roadblock for some donors and should be considered when selecting a fund.
Bottom Line
Donor-advised funds can streamline your charitable giving, make a bigger collective impact for organizations associated with the fund and confer big tax benefits for donors when used correctly. If you’re interested in investing in a donor-advised fund, get in touch with the team at HWM and start the process of finding the correct funds for your needs.
Donor-Advised Funds FAQ
What types of assets can be contributed to a DAF?
While many donors make cash contributions, a variety of assets can be given to a DAF. Depending on your fund’s management practices, you may be able to donate anything from stocks to real estate to personal property like art, jewelry or vehicles.
Are contributions to a DAF tax deductible?
Yes, any contributions made to a DAF will be deducted from your income for tax purposes in the year the contributions are made. Albeit they are still dependent on if you itemize or use the standard deduction.
How much money do you need to open a Donor-Advised Fund?
Minimum contributions to open a DAF vary widely depending on who manages the fund and who will be contributing to it. Some funds have no minimum for initial donations, and others require first-time investments of $10,000 or more.
Are there fees associated with Donor-Advised Funds?
In most cases, yes. Some smaller-scale DAF platforms do not charge administrative fees, but most DAF managers will have some sort of additional charge to keep the fund open and cover the costs of managing it.
