The use of donor-advised funds (DAF) as a charitable giving vehicle has exploded in popularity in recent years.
From 2017 to 2022, the number of DAF accounts more than quadrupled, increasing from approximately 463,000 to nearly two million, according to the National Philanthropic Trust.
What makes them so popular?
A common misconception about donor advised funds is that they’re only a good option for businesses, foundations, or families donating millions. In reality ,they are a great option for any individual looking for a streamlined, tax-efficient, and flexible way to support their favorite charities.
They’re a good option for anyone who wants to maximize their tax savings in a specific year and spread out their charitable donations in a way that aligns with their philanthropic goals over multiple years.
In this article, we’ll explore what a DAF is, how it works, and the benefits and downsides to opening one.
What is a Donor-Advised Fund?
A donor-advised fund is a tax-advantaged investment account like an IRA (meaning it has the opportunity to grow each year), but instead of using the assets from the account for retirement, you donate them to qualified charities.
You can fund a DAF with cash, securities, non-cash assets like real estate or complex assets like cryptocurrency, and contributions are tax-deductible in the year you make them—up to the IRS limit.
One of the most compelling features of a DAF is you don’t have to gift the funds to charity immediately. Placing them within the fund allows you to spread out that giving over time.
All contributions to donor-advised funds are irrevocable, and depending on where you set up your giving account, there may be minimum contribution and charitable gift requirements.
How Does a Donor-Advised Fund Work?
Setting up a donor-advised fund, contributing to it, and making grant recommendations from it is relatively simple. Here’s how it works.
- Choose a sponsoring organization. This is the company that manages the DAF. When you request grants from the fund, the sponsoring organization (also known as the custodian) approves it and transfers the assets to the charities. Your financial advisor can help you choose one.
- Open an account. Provide some basic information about yourself and make the minimum contribution required by the sponsoring organization to get started. DAFs do have administrative fees, but they tend to be low, and the tax savings of contributing to a donor-advised fund typically more than offset the cost of maintaining one.
- Contribute to the account. Transfer cash, securities or non-cash assets to the fund. There’s no limit to the number of contributions you can make each year, but there is a limit on what is deductible, so make sure you work with an advisor to fund the appropriate amount and maximize the benefits,
- Invest the assets. When you transfer assets to a donor-advised fund, you can keep them in cash so they’re available when you’re ready to issue a grant. Or you can invest them and enjoy tax-free growth on appreciated assets, which may allow you to give even more to causes you care about. An advisor can help you determine the amount to keep in cash, the amount to invest, and how to invest.
- Recommend grants. Choose eligible 501(c)(3) tax-exempt organizations to receive charitable funds from the DAF at any time. You can grant funds immediately or over several years.
Advantages of Donor-Advised Funds
Using a donor-advised fund to direct your charitable giving has several advantages.
Tax Benefits
The tax advantages are a major selling point of establishing a donor-advised fund. You get an immediate income tax deduction in the year you contribute to a DAF, and contributions can grow tax-free. But there are additional strategies you can use to get an even bigger bang for your buck.
When you donate appreciated securities you’ve held for more than a year, neither you nor the charitable organization pays capital gains tax on them. This can supersize a charitable donation to support your favorite causes at a level you may not have thought was feasible.
You can also front-load or “bunch” your donations every few years for a bigger tax reduction if you don’t typically exceed the standard deduction with your annual charitable giving.
Here’s how it works.
In 2024, the standard deduction for a married couple filing jointly is $29,200.
Let’s say that each year you max out the $10,000 limit of state and local taxes, pay $5,000 in mortgage interest, and give $10,000 in charitable contributions. That’s a total of $25,000 you could deduct from your income taxes.
But because the total is less than the standard deduction, itemizing doesn’t make sense.
However, if you “bunch” four years of charitable contributions in 2024 ($40,000), your total deduction for the year would be $55,000 ($40,000 + $10,000 + $5,000) — well above the standard deduction amount.
By itemizing your taxes, you benefit from the difference between your $55,000 in deductions and the standard deduction of $29,200.
Using this strategy allows you to take advantage of itemizing your deductions for a larger tax savings in the year you “bunch” your contributions while taking the standard deduction in the following years.
You grant the money to your favorite charities over time and repeat the process after the funds have been distributed.
While saving on your taxes shouldn’t be your primary motivation for giving, it may allow you to give more to the causes you care about.
Simplicity and Flexibility
Donor-advised funds offer a user-friendly and streamlined way to direct your charitable giving, making it easy to give to your favorite nonprofit organizations over and over again.
When you manage your giving through a DAF, all your donations are recorded in one place, so you only have to give your accountant one receipt at tax time.
Additionally, donor-advised funds allow you to decide when and how much to give on a schedule that works for you.
Considerations and Downsides of Donor Advised Funds
While DAFs have many benefits, there are some things to remember before establishing one.
Sponsoring Organization Approval
When you contribute assets to a DAF, you get to recommend the organizations you want to provide grants to. However, the custodian must approve it. Most of the time, that’s not a problem, but it’s possible they could deny your grant, which can happen if you are looking to support a cause that doesn’t have a legally operated 501(c)(3).
Granting Limitations
There are limitations on how you can use the assets in a DAF. You may not use DAF funds to contribute to political parties or individual candidates or to fulfill a pledge.
You also can’t use the funds for personal benefit. That means if you sign up for a table at a dinner auction, you must pay for the table out of pocket, not from your DAF account because you’ll enjoy dinner, entertainment and other perks.
This is another reason working with a financial advisor to set up a DAF can be useful. They can help you review your past and prospective donations to make sure the recipient and use is viable. If your primary donations are not allowed within a DAF, it doesn’t make sense to open one.
Deduction Limits
While DAF accounts provide tax benefits, you must keep in mind the deduction limitations. You can deduct up to 60% of your adjusted gross income (AGI) for cash contributions to a DAF and 30% for donations of appreciated securities. If your donation exceeds those limits, however, you can carry forward any unused deductions to future years.
Initial Setup: Costs and Requirements
The minimum financial commitment to start a DAF varies based on the sponsoring organization (custodian). Some have no minimum, while others may require an initial contribution of several thousand dollars.
Proactivity matters with a DAF. You must open and fund a DAF by December 31 to qualify for a tax deduction in the current year, but the reality is custodians get backed up as year-end approaches.
Because it can take several weeks to transfer assets from your account to a donor-advised fund that time of year, we usually recommend opening or contributing to a DAF by mid-November to play it safe.
Donor-Advised Fund Quick FAQs
If you’re unfamiliar with donor-advised funds and how they work, you may still have questions about whether they may be a good fit for you. Here are answers to some common questions about DAFs.
What are the tax advantages of a DAF?
Donor-advised funds have multiple tax advantages, including an immediate tax deduction — up to the IRS limit — in the year you make the contribution, plus tax-free growth on assets.
Additionally, if you contribute appreciated securities you’ve held for more than a year to your DAF account, neither you nor the charity will pay capital gains tax on it.
How do I make the most of my charitable donations through a DAF?
Bunching multiple years’ worth of contributions into a single year and contributing appreciated securities will help you maximize your tax savings.
Additionally, after retirement, you’ll want to consider whether it’s best to continue contributing your donor-advised fund or make charitable contributions from an IRA (known as a Qualified Charitable Distribution, or QCD).
Next Steps
You could open a donor-advised fund on your own or work with a financial advisor to help you maximize your tax savings and charitable contributions.
At Plancorp, we can help you set up your donor-advised fund, direct grants, and facilitate correspondence with your accountant.
When your account is open, our advisors can help you navigate the tax implications of using a DAF, including determining the best way to “bunch” your contributions and choosing the most tax-efficient lots of stock or mutual funds to transfer to the fund.
We can also help you decide if investing the assets in a DAF is right for you, create an investment strategy based on your goals and timeline, and review your investment options with you.
Because people are often in higher tax brackets when working compared to when they’re in retirement, there are unique considerations to think about as you approach retirement.
Our advisors run tax projections to guide decisions on pre- and post-retirement contributions, which can help determine whether it’s more advantageous to make charitable contributions from your DAF or IRA after you retire.
Additionally, we can facilitate the naming of your donor-advised fund’s beneficiaries, regardless of whether you choose to leave the assets directly to charity or have someone else manage the account after your death.
Not sure if a donor-advised fund fits into your wealth management plan? Take our two-minute financial analysis and get personalized feedback based on your answers.
