Yfat Yossifor
A Donor Advised Fund (DAF) is a simple, flexible, and tax-efficient way to give to your favorite charities. Consider three examples of DAFs in action:
Temporary surge in income. As a senior executive at a major corporation, Sally’s compensation package includes annual stock option grants that vest over four years. Sally decided earlier this year to exercise some of her vested stock options and use the proceeds to purchase a second home and add funds to her investment accounts. Because gains on stock option sales are taxed as ordinary income, Sally was looking for a way to reduce the tax bill on her temporary surge in income. A regular contributor to various philanthropic causes, Sally elected to pre-fund 5 years of charitable donations in a DAF. Because DAF contributions are treated as a gift to a public charity, the donor receives an upfront tax deduction while the distributions to charities can be postponed to a later date.
Helping charities who cannot accept appreciated securities. Donating appreciated securities rather than cash is a popular way to support charities. By doing so, the donor avoids paying capital gains taxes on the increase in value while simultaneously receiving a tax deduction equal to the value of the appreciated securities. But many charities, especially smaller ones, may only be able to accept cash. Funding a DAF with appreciated securities, which are then sold, can be a tax-efficient way to get proceeds into the coffers of charities who only accept cash.
Rebalancing an investment portfolio. John and Laura, now in their early 70s, had a large investment portfolio, but it was highly concentrated in just a handful of stocks. To reduce their risk, they elected to lower their concentrated positions and redeploy the capital into a more diversified and lower risk investment portfolio. To help lower the long-term capital gains taxes they would pay on the sale of the securities, they contributed appreciated securities to a DAF to pre-fund future charitable contributions. Like Sally in the first example, this enabled them to get an upfront tax deduction.
How do DAFs work in practice?
With a DAF, you transfer your assets, watch them grow, and decide which charities to contribute to when you are ready. DAFs are a particularly good choice for year-end giving if you are still not sure which charities to support.
Make a tax-deductible donation. Donate cash, stocks, bonds or more complex assets like real estate, private business interests and private company stock and get your tax receipt. You will be eligible for an immediate tax deduction based on the fair-market-value of the donated property. The DAF platform provider you select will then sell the contributed assets and credit your account with sale proceeds.
Support charities that are important to you, now or over time. You can use money in your DAF to support any IRS-qualified public charity. The DAF platform provider sponsoring your account will conduct due diligence to ensure the funds granted out of your account will be used for charitable purposes and is IRS-qualified.
Grow your donation, tax-free. While deciding which charities to support, you can elect to have your account invested in different investment products, creating the potential for even more money to be available for distribution to charities of your choice.
You cannot fulfill a pledge with your DAF. This rule is based on semantics. When a pledge is considered legally binding and a financial obligation of the donor, and the pledge is fulfilled using a DAF, the donor is viewed as getting a benefit from the DAF. This violates the Internal Revenue Code. However, a donor can set up recurring gifts from the DAF if there is no legally binding pledge behind the gifts. Fidelity Charitable, for example, recommends that donors avoid language with fund-raisers that imply a pledge and replace it with a non-binding letter of intent. For more on this topic, click here
How popular are DAFs?
Congress created the legal structure for DAFs in the late 1960s, but it took time for the concept to grow in popularity. It has since become the fastest growing charitable giving vehicle in the United States.
The National Philanthropic Trust, a non-profit focused on charitable giving, reported that $85.2 billion of charitable assets were held in approximately 285,000 DAF accounts in 2016. Total contributions to DAF accounts last year totaled $23.3 billion, with $15.8 billion being paid out to various charitable organizations.
Some of the biggest DAF providers include Fidelity Charitable, Schwab Charitable, and Vanguard Charitable. All of them have user-friendly web platforms that make donating and granting easy.
Dalya Inhaber, Ph.D., CFP ® is a financial advisor based in New York. She is the founder of Minerva Wealth Advisory, a Registered Investment Advisory firm. The mission of the company is to provide clients with tailored and unbiased financial planning and investment management. Dalya holds a Ph.D. in economics and statistics from the University of Michigan. The firm is named after Minerva - the Roman goddess of wisdom and knowledge. Minerva is often depicted with her sacred creature the owl, whose keen eyesight helps her navigate a path forward.