How to Make the Most of Donor-Advised Funds

Donor-advised funds (DAFs) are becoming one of the most popular and effective ways to make charitable gifts, and their use is likely to increase in coming years.

It is important to know the details of DAFs to maximize your tax benefits and the benefits to charities.

A DAF is created or sponsored by a charity. They began to take off in the 1990s after a charity affiliated with Fidelity Investments created the Charitable Gift Fund. Now, charitable arms of most major brokerage and mutual fund firms sponsor DAFs, with the largest organized by Fidelity, Schwab and Vanguard.

But there are many other DAFs. Many localities or regions have DAFs, often known as community foundations or community chests. Some individual charities have DAFs, and there are other national versions such as one operated by the National Philanthropic Foundation.

A DAF essentially enables an individual or family to create a version of the private foundations used by the very wealthy. The donor incurs few or no costs to create and operate a DAF account.

DAFs are so beneficial that there are reports many wealthy people make at least a portion of their charitable gifts through them instead of elaborate foundations and trusts.

You create an account at the DAF of your choice and transfer money or property to it. The DAF usually lets you choose how the account is invested, within limits.

You recommend charitable contributions to the DAF custodian, and it makes the donations. Some DAFs provide account creators with checkbooks to make donations directly.

You’re eligible to take a charitable contribution tax deduction in the year you transfer money or property to the DAF, regardless of when individual charities receive contributions from the DAF.

DAFs surged in popularity partly because the Tax Cuts and Jobs Act of 2017 doubled the standard deduction. You must itemize expenses on Schedule A of Form 1040 to deduct charitable contributions, and you itemize only when your total itemized expenses exceed the standard deduction. Few people itemize expenses now.

Some people use a DAF to bunch several years of charitable contributions in one year by making a lump sum contribution to the DAF and distributing it to charities over time.

Others use a DAF because they received a one-time windfall, say from the sale of an asset or a bonus or other boost in income. They take the charitable deduction in the current year and then take time to decide on individual charitable gifts. A DAF also makes it easier to keep track of many relatively small gifts to a number of charities.

Non-cash contributions might be made more easily with a DAF. Most large DAFs now routinely accept a wide range of assets, such as real estate, digital currencies, art, collections and more.

Suppose someone has a highly appreciated stock or mutual fund in a taxable account. She wants to benefit several charities and believes this is a good time to exit the security. Transferring the securities to a DAF that handles such transactions all the time is easier than transferring portions of the shares to individual charities.

Or a person generally wants to benefit charities but hasn’t decided which charities to bestow. He transfers the securities to a DAF now because it seems the optimum time to dispose of them. He now has time to develop a long-term giving strategy.

A DAF can be a family affair without the costs and administrative headaches of a family foundation. The head of the family can fund the DAF and then invite the rest of the family to join in planning how to distribute it over time.

The bottom line is the DAF lets you take a large charitable contribution deduction when the opportunity arises. Then, you have time to develop a strategy for giving it away to individual charities. The DAF makes it easy to move a large amount into the charitable fund and then distribute relatively small amounts to individual charities over time.

Here’s a classic use of a DAF.

Max Profits saved and invested over the years. After beginning serious retirement or estate planning, Max finds he has more wealth than is needed to fund the retirement years. Max plans to leave the bulk of the wealth to his family, but there’s enough to be generous to both the family and charities.

Max doesn’t have firm ideas of which causes and charities to benefit or how to divide the wealth among charities. In fact, the whole process seems overwhelming.

The first step for Max is to decide how much of the estate will go to charity. Then, move that amount into a DAF.

After the wealth is set aside in the DAF, Max has time to consider a range of charities and develop a long-term plan for distributing the wealth. There are no minimum annual distributions required from a DAF.

The process makes Max’s tax and estate planning more efficient and also makes the charitable giving more effective and efficient.

A DAF also makes it easier to give anonymously. That’s attractive to people who don’t want to be bombarded with charitable solicitations after giving to one charity or who want privacy for other reasons.

The DAF also has to vet donations, ensuring they’re made only to IRS-qualified charities, providing another layer of fraud protection.

Using a DAF generally allows donors to easily review their record of charitable giving instead of having to sift through individual checks from a bank account.

DAFs have their critics. They assert that there’s a lot of money sitting in DAFs while there are charities with needs. They believe that at a minimum DAFs should be subject to the rule that requires private foundations to donate at least 5% of their value each year. So far, the proposed legislation hasn’t received serious consideration in Congress.

The National Philanthropic Trust counters that DAFs distributed $45.7 billion to charities in 2021 and paid out 27.3% of their value to charities.

Donors should know that once money or property is transferred to a DAF, it belongs to the DAF. While donors may select investments and recommend charitable donations, legally these are only recommendations. The DAF doesn’t have to follow them. The money no longer belongs to you, and you can’t have it returned.

A DAF can make contributions only to IRS-qualified charities.

Most donor-advised funds allow you to start with $5,000. You can choose a DAF sponsored by the charitable arm of financial services companies or seek out a DAF sponsored by another charity.

You can learn of many local and regional DAFs at www.cof.org on its “community foundation locator.” DAFs sponsored by a charity or focused on a region usually require a minimum percentage of the contributions to be made to the associated charities. You also might want to check out the National Philanthropic Trust at nptrust.org.

Of course, compare fees and expenses. They won’t reduce your charitable deduction but will reduce the amount of money available to give.

Also, examine any giving limits. Some funds limit the number of individual contributions you can make or checks you can write each year without incurring additional expenses. There might be a minimum individual donation amount, and a minimum account balance might have to be maintained.