Since we’re into tax season now, I wanted to take a few minutes to tell you about DAFs. DAFs are not new; they’ve been around since the 1930s. But they’ve been popular as a tax-planning tool since the Tax Cuts and Jobs Act (TCJA) passed back in 2017. Here’s how they work:
- Make a sizeable donation to a DAF. Donating to a DAF, which acts like a “charitable bank,” is one way to bunch or aggregate your deductions for tax-wise giving. However, DAF contributions are irrevocable. You cannot change your mind and later reclaim the funds.
- Deduct the full amount in the year you fund the DAF. DAFs are established by nonprofit sponsoring organizations, so your entire contribution is available for the maximum allowable deduction in the year you make it. Plus, once you’ve funded a DAF, the sponsor typically invests the assets, and any returns they earn are tax-free. This can give your initial donation more giving power over time.
- Participate in granting DAF assets to your charities of choice. Over time, and as the name “donor-advised fund” suggests, you get to advise the DAF’s sponsoring organization on when to grant assets, and where those donations will go.
Thus, donating through a DAF may be preferred if you want to make a relatively sizeable donation for tax-planning or other purposes, you’d like to retain a say over what happens next to those assets, and you’re not yet ready to allocate all the money to your favorite causes.
Another common reason people turn to a DAF is to donate appreciated stocks in kind (without selling them first), when your intended recipients can only accept cash/liquid donations.
Beyond DAFs
DAFs aren’t for everyone. Along the spectrum of charitable giving choices, they’re relatively easy and affordable to establish, while still offering some of the benefits of a planned giving vehicle. As such, they fall somewhere between simply writing a check, versus taking on the time, costs and complexities of a charitable remainder trust, charitable lead trust, or private foundation.
That said, planned giving vehicles offer several important features that go beyond what a DAF can do for a family who is interested in establishing a lasting legacy. They also go beyond the scope of this article.
How Do You Differentiate DAFs?
If you decide a DAF would be useful, the next step is to select an organization to sponsor your contribution. Sponsors typically fall into three types:
- Public charities established by financial providers, like Fidelity, Schwab and Vanguard
- Independent national organizations, like the American Endowment Foundation and National Philanthropic Trust
- “Single issue” entities, like religious, educational or emergency aid organizations
Within and among these categories, DAFs are not entirely interchangeable. Whether you’re being guided by a professional advisor or you’re managing the selection process on your own, it’s worth doing some due diligence before you fund a DAF. Here are some key considerations:
Minimums – Different DAFs have different minimums for opening an account. For example, one sponsor may require $5,000 to get started, while another may have a higher threshold.
Fees – As with any investment account, expect administration fees. Just make sure they’re fair and transparent, so they don’t eat up all the benefits of having a DAF to begin with.
Acceptable Assets – Most DAFs will let you donate cash as well as stocks. Some may also accept other types of assets, such as real estate, private equity, or insurance.
Grant-Giving Policies – Some grant-giving policies are more flexible than others. For example, single-entity organizations may require that a percentage of your grants go to their cause, or only to local or certain kinds of causes. Some may be more specific than others regarding the minimum size and/or maximum frequency of your grant requests. Some have simplified the grant-making process through online automation; others have not.
Investment Policies – As touched on above, your DAF assets are typically invested in the market, so they can grow tax-free over time. But some investments are far more advisable than others for building long-term giving power! How much input will you have on investment selections? If you’re already working with an investment advisor, it can make good sense to choose an advisor-friendly DAF that allows them to manage the account assets in a prudent manner.
Transfer and Liquidation Policies – What happens to your DAF account when you die? Some sponsors allow you to name successors if you’d like to continue the account in perpetuity. Some allow you to name charitable organizations as beneficiaries. Some have a formula for distributing assets to past grant recipients. Some will roll the assets into their own endowment. (Most will at least do this as a last resort if there are no successors or past grant recipients.) Also, what if you decide you’d like to transfer your DAF to a different sponsoring organization during your lifetime? Find out if the organization you have in mind permits it.
Deciding on Your Definitive DAF
Selecting an ideal DAF sponsor for your tax planning and charitable intent usually involves a process of elimination. To narrow the field, decide which DAF features matter the most to you, and which ones may be deal-breakers.
Once you’ve got your sponsor in place, you’ll then be free to support the causes that are near and dear to your heart. Good giving feels great – for donor and recipient alike.