If you’re charitably inclined there may be a better way to donate to charity. Instead of writing a check or using a credit card, consider the use of a donor-advised fund.
Donor-advised funds allow you to donate to your favorite charities, grow philanthropically earmarked money for future donations, and reap a tax deduction in the current year.
How donor-advised funds work and why people like them
Donor-advised funds (DAFs) are a flexible and tax-efficient way to give to your favorite charities. A DAF is a charitable investment account established by you for the sole purpose of supporting your chosen charitable organizations.
DAFs appeal to investors because they allow a contribution of appreciated assets held for at least one year to their DAF at full fair market value without paying capital gains taxes on the appreciation of the investment. Donors receive a tax deduction in the contribution year but there is no requirement to disburse funds in the same year, thereby separating the act of receiving the tax benefit and the actual making of a donation.
DAFs are offered by large institutions including Fidelity, Schwab, and Vanguard, as well as by faith-based organizations and community foundations. Some individuals prefer to work with a low-cost provider while others choose to work with a local organization; there are benefits to both.
Contributing to a donor-advised fund
Donations to a DAF can be made in cash, publicly traded securities, and even in shares of a privately held business. While making a cash donation still generates a charitable gift for tax purposes, donating appreciated securities is one of DAF’s major benefits. After a meaningful bull market in stocks, donating appreciated securities and avoiding capital gains tax can provide meaningful tax savings. Another increasingly popular use is for small business owners to gift a portion of their business to a DAF prior to selling the business, allowing this portion of their gain to avoid capital gains tax.
Much like a 401(k), each DAF has a menu of investment pools available, offering different types of investment choices. Fidelity, for example, has actively managed and indexed pools, aggressive growth options and more conservative ones, as well as sustainable and impact investing choices. Deciding on an investment strategy for charitable giving, much like investing retirement funds, depends on whether you want to employ a short-term granting approach, to establish a pool of money for gifting at a later date, or to build a vehicle used to create an intergenerational legacy.
Any IRS-qualified public charity is eligible to receive grants from your DAF. So, you can continue to support the same smaller local charities, your alma mater, religious organizations or national charities. Most private foundations do not qualify, nor do overseas charities. However, you can make a grant to an American intermediary charity, such as GlobalGiving, that will then send a grant to your preferred organization for a specified fee.
Like a 401(k) or brokerage account, there are fees associated with DAF accounts. There are typically multiple layers of fees. First, there is an ongoing cost to have a DAF, typically ranging from 0.50% to 1.0% annually with a minimum dollar amount per year. Second, the investment pools available within the DAF have fees associated. Some DAFs offer model portfolios while others offer both actively and passively managed individual investment pools. As such, fees vary widely, but range from just a few basis points (a fraction of a percent) for passively managed investments to over 1% for actively managed options. Some plans, especially for accounts over $250,000, offer the ability to hire a financial advisor, who will also charge a fee. However, advisor-managed accounts may invest in individual securities which can offset the overall cost.
While understanding the fee landscape is important, the cost of having a DAF is easily outweighed by the benefit.
Not all funds and situations are the same
Donor-advised funds are likely to continue growing in popularity for their convenience and tax advantages. Because no two people’s situations are the same, seeking personalized investment guidance from a professional can help ensure that your charitable giving and investing options are appropriate for your individual circumstances.
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