WHAT IS A DONOR-ADVISED FUND?
A Donor-Advised Fund (DAF) is a private investment account maintained by a third party, known as a sponsor, to manage charitable donations on behalf of an individual, family, or organization.
Donor-Advised Funds offer a flexible way for donors to contribute cash and non-cash assets to the fund while also allowing donors to still maintain some control over the specific timing and charities to give to.
In addition, donors can receive immediate tax benefits while still maintaining some level of control over the donated assets.
HOW DOES A DONOR-ADVISED FUND WORK?
Donor-Advised Funds have become increasingly popular because they offer a simple, easy, and flexible way to contribute to charity.
The first step is to choose a sponsor. A sponsor is a company or organization that maintains the DAF, allowing you to contribute funds and give to charities of your choosing. The majority of sponsors are simply charitable arms of existing financial institutions such as Fidelity Charitable, Schwab Charitable, and Vanguard Charitable.
The second step is to donate. When donating to a Donor-Advised Fund, donors can contribute cash or non-cash assets such as stocks, real estate, private business interests, and even cryptocurrency. It’s important to note that once donations are made, they are irrevocable.
After your donation, you will receive an immediate federal/state tax deduction.
The third step is to name the account, its successors, and its beneficiaries. Your sponsors will allow you to personalize your DAF account, giving you the ability to appoint friends or family to help you manage the DAF and even designate successors or charitable beneficiaries within the account. Successors would take over the account if you were to pass away, and beneficiaries are the charitable organizations that will receive the remaining funds.
Once the contribution is placed in the account, you can manage the assets within your Donor-Advised Fund, choosing to let them grow and compound tax-free or distribute them to a charity of your choosing.
Lastly, the donor (that’s you) recommends grants from their funds to qualified charities. It’s important to note that technically sponsors are not required by law to follow the donor’s recommendations, but they almost always do. The rare exception will be if you are recommending a grant to a non-qualified charitable organization.
WHAT ARE THE TAX BENEFITS OF A DONOR-ADVISED FUND?
First, when contributing to a DAF, donors receive an immediate tax deduction, even though their assets can continue growing within the DAF. This allows for added flexibility around timing, gifting, and asset appreciation, all while receiving the maximum deduction now.
Second, donors can grow their charitable dollars tax-free. Once you’ve contributed to your DAF, you can continue to invest and grow your charitable dollars, allowing you to maximize the amount your favorite charities will receive without paying taxes on any of the growth. This allows for even more money to eventually end up in the hands of the designated charities of your choosing.
Third, DAFs allow you to reduce your tax burden during a windfall or high-income year. For example, suppose you have a potentially high tax year due to an inheritance, sale of a business, or another high liquidity event. In that case, you can contribute to a DAF and receive an immediate tax deduction, lowering your overall tax liability.
Fourth, DAFs allow you to contribute appreciated assets without recognizing any capital gains. This can be very valuable for those with highly appreciated assets that want to make charitable contributions but want to avoid realizing capital gains. The alternative approach would be to sell highly appreciated securities, triggering capital gains tax, which would ultimately reduce the amount you have available for charitable donations.
WHAT ARE THE DRAWBACKS OF A DONOR-ADVISED FUND?
While Donor-Advised Funds have largely grown in popularity due to their ease of access, tax benefits, and gifting control, they do have a couple of drawbacks worth noting.
First, most DAFs come with fees and minimum donation requirements, though exact amounts will vary from sponsor to sponsor. It is important to evaluate the fee levels when establishing a DAF and ensure that you can meet the minimum donation requirements, if any.
Second, DAFs often draw criticism because the funds can sit in the account indefinitely. Unlike a private foundation, where a minimum of 5% of the assets must be donated annually, there are no annual distribution requirements for DAFs. This has led many skeptics to question the integrity of DAFs and whether they are actually beneficial for charities, which may not receive the money for an extended period of time.
WHAT HAPPENS TO YOUR CONTRIBUTIONS WHEN YOU PASS AWAY?
Generally, there are two possible options for your DAF when you pass away. You can choose to have the DAF distributed to the charitable beneficiaries of your choosing in whatever amounts you specify. Or, you can appoint a successor who will take control of the management and administration of the DAF once you pass away.
IDAHO MEDICAL ASSOCIATION FINANCIAL SERVICES IS HERE TO HELP.
If you’re interested in working with a fiduciary CFP® professional to help craft a unique gifting strategy, complete with a current tax analysis to deliver your financial goals, then Idaho Medical Association Financial Services is here to help.
Idaho Medical Association Financial Services is among the top Wealth Management firms in Idaho, specializing in investment planning for doctors. At Idaho Medical Association Financial Services, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.
For our team at Idaho Medical Association Financial Services, it’s about so much more than money. It’s about serving medical professionals all across Idaho and helping them achieve freedom and flexibility in their lives. To learn more about tax planning in Boise or schedule a no-cost consultation, visit our website at Idaho Medical Association Financial Services or call (208)-504-1736.
