83% of Americans give annually to charity. Charitable giving is clearly an integral part of the culture of successful families in this country. While Americans are generous with their giving, they are often giving inefficiently from a tax perspective. Families could be saving significant dollars by donating securities or assets with long-term appreciation to charity or to a donor advised fund (DAF) instead of contributing cash directly to charities (which is more typical). Donor advised funds have been the fastest growing philanthropic vehicle in the nation over the past few years, yet a recent survey by Fidelity Investments found that 70% of investors had never heard of them. Donor advised funds offer wealthy and middle-class families many of the benefits of having a charitable private family foundation without the costs, administrative hassles, and high minimum asset levels that typically go with them. Many very wealthy families are choosing to use donor advised funds rather than setting up a private family foundation due to the dramatically lower costs and administrative headaches. Some wealthy families are even shutting down their private foundations and moving that money into a donor advised fund program. Private foundations are often uneconomical in sizes of under $3-$4 million. Donor advised funds are a simple, affordable, and flexible charitable-giving tool.
What are Donor Advised Funds and how do they work?
A donor advised fund (DAF) is a separate account of a sponsoring charitable organization. They can be set up at a wide variety on sponsoring organizations including various large existing charities as well as financial firms such as Fidelity, Schwab, and Vanguard. From this account, donors recommend grants to other charitable organizations. Most DAF programs have the ability to accept appreciated securities as donations. When you contribute a donation (of appreciated securities or cash) to your DAF you get the full appreciated market value of the asset as a tax deduction, in the year of the donation. Upon receiving the gifts the DAF sponsor liquidates the donated assets tax-free and invests the proceeds in a variety of investment options. Generally the donor gets to recommend how the assets are invested among a number of investment choices. Over time the donor can recommend grants to IRS qualified charities and the DAF sponsor distributes cash grants to these recommended charities. Grants may be made over many years into the future even if a large donation was made in just the first year. These DAF accounts are quite easy and cheap to set up. Schwab and Fidelity’s donor advised fund programs require a minimum initial contribution of only $5,000, minimum additional contribution amounts of $500-$1,000, and minimum grant sizes of only $100.
Advantages of using a Donor Advised Fund for your Charitable Giving:
1. An immediate tax deduction of the full appreciated value of the securities donated. You avoid paying any capital gains tax on the sale of the asset. This is much more tax efficient than contributing cash to your charities. You get to give the full appreciated value of the securities to your charities rather than the smaller after-tax proceeds. Make sure you have held the appreciated asset at least a year before donating.
2. Simplification. You making one donation of appreciated securities to your DAF, and then you get to grant multiple smaller amounts of cash to each of your favorite charities. This is much easier administratively than donating smaller amounts of appreciated stock separately to each of your charities (some of which may not accept securities). You only need one tax substantiation letter using a DAF, versus multiple letters if you are donating separately to each charity. DAF’s make it easy to contribute appreciated securities to them. You can also automate your giving from this account on a monthly or other regular basis to your favorite charities. The DAF sponsor does all the administrative and recordkeeping work, and sends the checks to the charities for you.
3. Post-donation appreciation may increase the size of your grants. Since you may donate to your DAF in one year and may grant the money to your charities several years later, any appreciation of the investments during that time will result in larger donations to your favorite charities. Assets in your DAF account can grow faster because they appreciate free of taxes.
4. Good Estate Tax Planning. All donations made to a DAF are removed from the donor’s estate immediately. A large donation to a DAF in the current year may provide many years of future giving to charities and immediately reduces potential estate taxes. Simply planning to give the same amounts directly to charities each year from the donor’s estate provides no shelter from potential estate taxes.
5. Low Minimums, Costs and Ease of Use. As described above many of the programs such as those at Fidelity and Charles Schwab have very low minimums for contributions and donations. They are easy to set up and use and they typically have no startup costs.
6. Ability to donate now and get the tax deduction, and decide where to give later. These funds allow you time (years if you wish) to research and decide where you wish to give.
7. Create a legacy and start a family tradition of philanthropy. DAF’s allow you to get your kids involved in helping pick out the charities and try to teach and inspire them about philanthropy. It is possible to assign your children as successor advisors and extend the grant-advising privilege to them after your death.
8. No minimum distribution requirements or legal red tape like separate tax returns (unlike foundations which must distribute 5% of assets annually and file separate tax returns). Private foundations must pay excise taxes of 1%-2% of net investment income annually, and DAF’s do not.
9. Privacy. Gifts from donor-advised funds can be made anonymously. Private foundations must make their tax returns available to the public, and sometimes families get inundated with requests because of that.
Disadvantages of Using Donor Advised Fund’s:
1. Administrative Costs. While dramatically lower than a private foundation, the DAF sponsors all charge some sort of administrative fee to run the program. These administrative charges cover the cost of keeping track of all the accounts and donations, and distributing the grants. Schwab and Fidelity charge a .60% administrative fee for the first $500,000 in the plan and the fees drop to only about .20% for accounts with $1.5 million or more. These fees have been cut significantly over the past several years. The underlying investment fund options charge a typical expense ratio of about .50-.65%. Other DAF sponsors may charge significantly higher fees that this.
2. Donations are Irrevocable. Once you donate the money to your DAF you can’t get it back. You are still in control of it, but it can only be donated to charities and given away. Only donate what you are sure you won’t need yourself or for other purposes.
3. Restrictions. You can’t use a grant from your DAF to make good on a personal pledge to a charity. You also can’t donate to a charity with the expectation of any personal gain or benefit (concert tickets, etc.). In some DAF’s the investment choices are somewhat limited.
4. No Income to You. DAF’s are not a technique if the donor wants income for themselves or their family from the donated asset. If income is a priority, the donor should consider other vehicles such as a Charitable Remainder Trust.
5. No Ability to Hire Staff. Since all of the administrate work is done by the sponsoring organization, the donor themselves cannot hire family members to do the work as they might with a private family foundatio