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By Melissa Weisz, CFP

Donor-advised funds (DAFs) have been part of charitable giving strategies since the 1930s and are now the fastest-growing charitable giving vehicle in the United States according to Fidelity Charitable. DAFs are giving accounts established at 501(c)(3) public charities, also known as sponsoring organizations, which individuals utilize to facilitate charitable giving. DAFs enable donors to coordinate charitable giving with robust tax and investment planning benefits through relatively simple and low-cost accounts.

Melissa holds the CERTIFIED FINANCIAL PLANNER™ and Chartered Financial Analyst® designations, with over 15 years of experience in the financial industry. She is responsible for advising clients in the areas of financial planning and investment management.  Melissa currently serves on the firm’s Financial Planning Committee and has served as an Investment Committee member.  Melissa co-chairs RegentAtlantic’s Senior Solutions specialty practice, helping retirees to navigate issues around healthcare and legacy planning.  Melissa is a featured speaker and has been quoted in financial news media, including Bloomberg, Wealth Management Magazine, and Yahoo Finance.

 

Melissa graduated with a Bachelor of Science from Rutgers, The State University of New Jersey, with honors. She currently serves as a mentor in Rutgers Business School’s TeamUP program. She is a member of the CFA Institute, Financial Planning Association, and CFA Society New York.  Prior to joining RegentAtlantic, Melissa served as Vice President and Advisory Services Analyst at an independent Registered Investment Advisor in Parsippany, NJ.

Melissa Weisz

DAFs are separate investment accounts or funds established by charitable organizations such as community foundations and public charities affiliated with national financial service firms. To establish a DAF, individuals make tax-deductible donations to the sponsoring charitable organization. At this point, the sponsoring organization has legal control over the assets. However, the donor, or a named successor advisor, retains advisory privileges over how the assets should be invested and distributed, either immediately or over time, via grants that will be made from the DAF to IRS-qualified charities the donor recommends.

Any time you are giving to charity, it is important to assess the optimal funding source of donations. Depending on your situation, you may wish to donate cash, securities, illiquid assets, or IRA assets if you are over age 70.5.

One of the benefits of DAFs is that donors can contribute long-term appreciated securities and receive a tax deduction for the fair market value donated. As with all donations of appreciated securities, it is important to ensure that the securities have been held for at least one year to deduct the full fair market value. Donations of securities with short-term gains, held less than one year, may only receive a deduction for the cost basis.

It is advantageous to fund charitable giving with long-term appreciated securities because the donor will avoid capital gains tax, and charities are tax-exempt entities that can sell appreciated securities tax-free.

Diversify Concentrated Stock Positions Tax-Free

DAFs offer investment options such as mutual funds and investment pools. For investors with concentrated stock positions, which are often long-term and appreciated, donors can contribute stock to their DAF and receive a tax deduction for the fair market value. Upon donation, the concentrated position is liquidated in the DAF tax-free, and the donor can direct how the cash proceeds should be invested among the DAF’s available investment options.

Within a DAF, a donor’s investment strategy should be guided by their risk tolerance and time horizon. For example, if a donor plans to make grants from the DAF quickly, it may be prudent to direct the DAF to invest in a money market fund or conservative investment option. Alternatively, for long-term charitable funding goals, the DAF may be invested more aggressively.

Since sponsoring organizations are public charities, any interest, dividends, and capital gains earned in a DAF are tax-free.

A DAF can remain invested over the donor’s lifetime, and the donor may name a successor advisor to direct the account when the donor is no longer willing or able to serve as the advisor, or after their passing. This creates the opportunity for years of tax-free growth for funding future charitable goals.

Bunch Charitable Donations and Grant at Your Pace

Under the Tax Cuts and Jobs Act (TCJA) of 2017, the standard deduction nearly doubled, and many taxpayers will not itemize deductions again until TCJA sunsets at the end of 2025. To benefit from itemized deductions, donors can consider bunching, or combining, several years' worth of regular charitable giving into a single tax year by funding a DAF. Then, grants can be made in subsequent years at the donor’s desired pace. Bunching donations allows itemized deductions to exceed the standard deduction when donors may otherwise be unable to itemize with just a single year of charitable giving.

In 2022, the charitable contribution deduction for DAFs is limited to 60% of adjusted gross income (AGI) for cash gifts and 30% of AGI for gifts of stock. Charitable deductions can be carried forward for up to five years if they cannot be used in the current tax year due to these AGI limits.

DAFs provide flexibility in the types of assets that can be donated. While many charities can accept publicly traded securities such as stocks, mutual funds, and bonds, it is more difficult to donate alternative assets, particularly to smaller charities.

DAFs are able to accept donations of alternative and illiquid assets. These assets may include privately held businesses, real estate, artwork, and employee stock awards. For these assets, the donor and DAF sponsor will need to work closely on due diligence, along with a professional tax advisor, due to the complexities of this planning.

DAFs Can Be a Retirement Account Beneficiary

A DAF can be named as a retirement account beneficiary. Pre-tax retirement assets are an ideal funding vehicle for charitable giving in an estate plan since charities receive the full amount of the retirement account tax-free, whereas individual beneficiaries are subject to income tax on distributions. Moreover, inherited retirement accounts are currently required to be distributed in full within 10 years following the owner’s passing, depending on the beneficiary’s age and relationship to the original owner, with some exceptions (e.g., spouses).

To maximize tax efficiency for heirs, cash, life insurance, and after-tax accounts and property that are eligible for a step-up in cost basis are generally better left to individuals, while pre-tax retirement accounts are well-suited to fund charitable goals.

While the donor is living, a successor DAF advisor can be named to make grant recommendations after their passing. This is a simple way to give heirs a meaningful, hands-on approach to charitable giving.

Donor-Advised Fund Providers

DAFs have been a well-established staple of community foundations since the 1930s. Beginning in the 1990s, national financial service firms, including Fidelity, Vanguard, and Charles Schwab, established 501(c)(3) public charities to offer DAFs serviced on their investment platforms. Some larger charities also offer their own organization-specific DAFs.

Fees for DAFs typically start around 0.6% per year, with little to no minimum initial investment requirement. DAFs are also subject to underlying investment expenses for mutual funds, investment pools, and advisory fees if professionally managed.

Donor-Advised Funds Offer Flexibility

Much of the popularity of DAFs is due to the flexibility of funding, investing, and ultimately granting funds to charity. For tax planning, donors can supercharge charitable giving in specific tax years by funding a DAF with the intention to invest and direct grants from the account in years to follow.

Donors can contribute long-term appreciated securities to avoid capital gains tax, receive a charitable deduction for the fair market value of donations, and continue to invest in a DAF tax-free. Finally, donors may recommend grants immediately or over time and name a successor advisor to implement charitable goals beyond their lifetime. 

About the Author: Melissa Weisz, CFP®

Melissa holds the CERTIFIED FINANCIAL PLANNER™ and Chartered Financial Analyst® designations, with over 15 years of experience in the financial industry. She is responsible for advising clients in the areas of financial planning and investment management. Melissa currently serves on the firm’s Financial Planning Committee and has served as an Investment Committee member. Melissa co-chairs RegentAtlantic’s Senior Solutions specialty practice, helping retirees to navigate issues around healthcare and legacy planning. Melissa is a featured speaker and has been quoted in financial news media, including Bloomberg, Wealth Management Magazine, and Yahoo Finance.

Melissa graduated with a Bachelor of Science from Rutgers, The State University of New Jersey, with honors. She currently serves as a mentor in Rutgers Business School’s TeamUP program. She is a member of the CFA Institute, Financial Planning Association, and CFA Society New York. Prior to joining RegentAtlantic, Melissa served as Vice President and Advisory Services Analyst at an independent Registered Investment Advisor in Parsippany, NJ.