How to Use a Donor-Advised Fund for Your Charitable Giving
By Russell W. Hall, CFP®
With the holidays and the end of the year approaching, our thoughts go to that happiest of subjects—tax-saving strategies!
That’s tongue-in-cheek, of course, but this is indeed a good time to take an inventory of the year and take advantage of any chance to save on taxes. One of those strategies is donating to charity, and although tax law changes have made charitable contributions less attractive for some people, options are still available.
First, a word of caution: We always say that any decision to donate should start with a charitable intent, not a tax deduction. This may seem obvious, but the math of donating $1.00 to charity to save $0.25 worth of taxes doesn’t work—you’ve still got $0.75 less in your pocket than you did before. So, you should really be donating because you want to support your favorite charitable organization.
With that advice out of the way, what’s the best way to give? It depends on your situation, but generally it’s more beneficial to give away appreciated securities/investments if you have them than it is to donate cash. That’s because you avoid selling that investment in the future and the subsequent taxation on capital gains (the difference between what you originally paid and the current value). The charity can then sell the security and get the full value, tax-free.
Advantages of Donor-Advised Funds
It should be noted that there are different limitations for the amount of charitable donations you can deduct on your taxes. Gifts of securities or other real property are limited to 30% of your adjusted gross income, while cash has a much higher limit of 60%. For some people, those limitations may affect the way that they choose to give.
In addition, some smaller charities may not be equipped to handle donations other than cash. In that case, a donor-advised fund (DAF) may be helpful. This is an account set up at a 501(c)(3) public charity—Schwab Charitable, Fidelity Charitable, and National Philanthropic Trust are some of the largest—that allows individuals to donate and receive an immediate tax deduction.
In a way, a DAF is similar to a private foundation, but with less overhead, cost, and maintenance. There are small minimums to open a DAF as well, typically around $5,000.
On the downside, there’s less control with a donor-advised fund. Technically the gift is completed at donation and out of the donor’s hands, and the donor can only “advise” (hence the name) the sponsoring organization where they would like the funds to be sent.
In practice, however, the public charity will mostly follow the wishes of the donor, unless the donor asks to have the money sent to an organization that is not tax-exempt.
Another great reason to use DAF is flexibility, and that’s one of the main reasons why these funds are the fastest-growing charitable vehicles in the United States.
As we alluded to earlier, changes in the tax law have resulted in many more people taking the standard deduction on their federal taxes. This means that they could potentially not see any tax deduction value for their charitable donation since their total itemized deductions would still be less than the standard deduction.
One way around this issue is to “bunch” donations—give two or more years’ worth of contributions in one year and then just take the standard deduction the following year(s). A donor-advised fund is ideal for this purpose since you get the deduction at the time of the initial gift but do not have to send out the money from the fund right away.
Instead, the proceeds can be held (and even sometimes invested) until you would like the money to actually get to the charity. This strategy can also be helpful if you are facing a higher-than-normal tax year because of stock option grants or other unusual amounts of income.
In short, a donor-advised fund can be a great way to make the most out of your charitable tax deduction or get different types of non-cash donations to smaller charities.
Our Fullerton financial advisory firm is happy to help you find out more about donor-advised funds and other tax-saving strategies. Schedule a 15-minute discovery call with a fee-only financial advisor.