A donor-advised fund (DAF) is like a mini-foundation that anyone can set up without the expense or a lot of paperwork. For our clients, it can be a great way to donate to charity without hassle, but it comes with other perks.
First, how a donor-advised fund works:
Through a custodian such as Fidelity or Schwab, you set up your DAF and deposit money or appreciated assets into it. You then direct the fund to distribute cash to any qualified non-profit organization, such as the Sierra Club or Doctors Without Borders.
Why donor-advised funds are great, in my opinion:
- You get the regular tax deduction for charitable donations for the money you contribute to the DAF, for example, if you contribute $10,000 to your DAF and your marginal tax rate is 50%, the contribution will reduce your tax by $5,000. You could get the same result by writing a check directly to a charitable organization, but with a DAF, there’s a lot more to love...
- You can contribute appreciated securities and avoid paying capital gains tax. For example, if you donate $10,000 of Mutual Fund XYZ, which you originally purchased for $4,000, you’ll avoid paying capital gains tax on $6,000 of appreciation—as long as you owned it for more than a year. Between the charitable donation deduction and capital gains tax avoidance, you could easily save $7,000 or more, making the true cost of your $10,000 donation $3,000 or less.
- DAFs are terrific tools for diversifying concentrated positions. As soon as you contribute the appreciated positions to the DAF, you can sell the positions without tax consequences.
- You can invest DAF funds in any security that you can normally invest in through Fidelity or Schwab. Basically, any stock or mutual fund.
- You report the charitable deduction when you contribute cash or securities to the DAF, but you can distribute money to your charitable organizations over an extended period of time. If you expect taxes to be high this year, you can contribute several years’ worth of charitable giving in the current tax year, get a larger deduction this year, and then distribute the money to your charitable organizations over as many years as you’d like.How does all of this work? Fidelity and Schwab have created their own non-profit organizations whose mission is to facilitate these donations. So, the contributions to your DAF are the reportable charitable donations. Fidelity’s and Schwab’s Charitable Gift organizations will hold the funds, follow your instructions for distributing funds to your charitable organizations, maintain records, and maybe best of all…
- At the end of the year, you’ll get one simple statement to submit with your taxes. You don’t have to worry about keeping track of receipts or acknowledgements at tax time.
- All of this makes your personal financial planning simpler and more accurate. You can log in to the website and see exactly how much you’ve contributed to your organizations over the years, and then plan out future charity contributions accordingly. You can track how your charity budget is doing over time and make informed decisions about your goals for charitable giving.
Of course, there are administrative fees, but they’re low. This is a cost-effective way to have your own charitable fund without the overhead and with greater tax benefits and more flexibility than a private foundation. Overall, contributing to charity through a donor-advised fund is something I highly recommend.