Donor-Advised Funds: A Smart Charitable Giving Strategy for Retirees

Donor-advised funds (DAFs) have become an increasingly popular charitable giving tool that provides a simple and effective way for individuals to make a meaningful impact on the causes they care about. This comprehensive guide will provide an in-depth look at donor-advised funds, including the benefits they offer, how they work, who can benefit from them, what types of charities are eligible recipients, and step-by-step instructions for setting one up.

Key Takeaways

• Donor-advised funds offer a simple, tax-smart way for donors to contribute to a charitable account today and recommend grants to nonprofits over time.
• DAFs provide immediate tax deductions, investment options, flexibility, lower costs, and streamlined administration compared to alternatives.
• Individuals, families, and even retirement donors can benefit from using DAFs as part of their philanthropic strategy.
• Nearly all IRS 501(c)(3) public charities are eligible for grant recommendations from your donor-advised fund after review.
• Work with sponsoring charities like community foundations or financial services firms to establish and contribute to your donor-advised fund.
• Donor-advised funds make strategic charitable giving accessible for donors at all income levels looking to make meaningful impacts.

What is a Donor-Advised Fund?

A donor-advised fund (DAF) is a charitable investment account used to manage the philanthropic contributions of an individual, family, or organization. The funds are administered by a third party known as a sponsoring organization. A donor-advised allows donors to make irrevocable charitable contributions to the account, receive immediate tax deductions, and then recommend grants from the fund's assets to their favorite charities over time.

DAFs are sponsored by public charities, often community foundations or financial services companies with affiliated charitable arms. When you open a DAF, you make a tax-deductible donation to the sponsoring organization's charitable account. You can then recommend grants to qualified public charities whenever you choose. The sponsoring charity formally approves each grant recommendation.

Some key features of donor-advised funds include:

• Immediate tax deduction: Donors receive an immediate income tax deduction in the year they contribute to the DAF, even if they recommend grants from the fund over multiple years.
• Flexibility: DAFs allow donors to recommend grants to multiple charities over an extended time period as their interests and priorities change.
• Control: Donors maintain advisory privileges to recommend grants from the fund to charities of their choosing.
• Investment options: The charitable sponsor typically invests the DAF assets, allowing them to potentially grow over time and increase the funds available for grantmaking.
• Simplicity: DAFs provide a simple, convenient way for donors to centralize and manage their giving through one account.
• Lower costs: DAFs have lower administrative fees and costs compared to other charitable giving vehicles like private foundations.

So in summary, a donor-advised fund allows you to make a tax-deductible charitable contribution to a sponsoring charity that invests and administers the funds. You then recommend grants from the fund to support nonprofits you care about over time.

Benefits of Using a Donor-Advised Fund

Donor-advised funds offer several compelling benefits that make them an appealing philanthropic tool:

Immediate Tax Deductions

One of the key advantages of DAFs is that they provide donors with immediate tax deductions for their charitable contributions in the year they're made to the fund. This is true even if you recommend grants from the fund over the course of multiple years.

This can provide an incentive for donors to "bunch" several years' worth of donations into one year to exceed the standard deduction threshold and potentially itemize. Itemizing allows you to deduct more and reduce your taxable income for that year.

For example, a business owner with a particularly profitable year could contribute a large amount to a DAF to get a sizable deduction. They could then recommend grants over time in later years when their income may be lower.

Flexibility and Control Over Giving

DAFs provide flexibility to recommend grants to multiple charities over an extended time period. This allows donors to easily adapt their giving as their charitable priorities and interests evolve.

You maintain the ability to recommend grants from the fund to nonprofits of your choosing. Unlike other fund structures like private foundations, you don't have to go through an extensive application process for every grant. This allows you to respond quickly to provide support at the time it's most needed.

Potential for Investment and Growth

When you contribute assets to a DAF, they are invested by the sponsoring charity and have the potential to grow over time. This enables your philanthropic capital to increase, allowing you to make even more funds available for grantmaking to charities.

Many DAF sponsors offer a range of investment options to match your risk tolerance and time horizon. Working with the sponsor, you can develop an investment strategy aimed at maximizing growth to enhance your charitable impact.

Simple, Convenient Administration

Opening and maintaining a donor-advised fund is relatively simple and convenient compared to other charitable giving vehicles. The sponsoring charity handles all of the administrative, legal, and reporting requirements.

With a DAF, you can easily manage all of your giving through one centralized account and avoid having to work with multiple organizations separately. This simplifies your personal philanthropic activities.

Lower Costs Than Alternatives

Donor-advised funds tend to have lower costs associated with them compared to alternatives like private foundations or other charitable trusts. DAFs do not require the establishment of a separate legal entity or compliance with the more extensive rules, regulations, and excise taxes that private foundations face.

The administrative fees charged by DAF sponsors are also typically lower than those of other options. This enables more of your contributed funds to go directly to charity rather than overhead expenses.

What Qualifies for a Donor-Advised Fund?

Donor-advised funds can accept a wide variety of assets, which makes them an appealing option for retirees looking to maximize their charitable impact. Contributions to a DAF can be made using both cash and non-cash assets. Here is a breakdown of the types of assets that qualify:

• Cash Contributions: Cash donations are the most straightforward way to fund a DAF and are eligible for an immediate tax deduction up to 60% of adjusted gross income (AGI). For retirees, this is a simple option that provides immediate tax benefits while supporting charitable causes.
       
• Publicly Traded Securities: One of the most common non-cash contributions to a DAF is publicly traded securities, such as stocks, bonds, and mutual funds. When retirees contribute appreciated securities that they have held for more than one year, they are eligible for a tax deduction equal to the fair market value of the asset, up to 30% of AGI. Additionally, they avoid paying capital gains tax on the appreciation, which can result in significant tax savings.
       
• Real Estate: Real estate properties, including residential, commercial, and undeveloped land, can also be donated to a DAF. Contributing real estate can be complex, as it typically requires an appraisal and a transfer of ownership, but it can provide substantial tax benefits. Retirees who have held real estate for a long time and have seen significant appreciation can use a DAF to avoid capital gains taxes while supporting their philanthropic goals.
       
• Private Business Interests: Private business interests, such as shares in a closely held corporation, limited liability company (LLC), or limited partnership (LP), can qualify for contribution to a donor-advised fund. This can be a tax-efficient way for retirees who are business owners to transition from business ownership while creating a lasting charitable legacy. These contributions typically require additional due diligence from the sponsoring organization to ensure compliance with IRS regulations.
       
• Cryptocurrency: Cryptocurrencies, such as Bitcoin and Ethereum, are increasingly being accepted by DAF providers. Similar to appreciated securities, donating cryptocurrency that has appreciated in value can allow retirees to take a fair market value deduction without incurring capital gains taxes.
       
• Collectibles and Fine Art: Collectibles, such as art, antiques, or other valuable items, may also qualify for contribution to a DAF. However, these contributions can be more complex, as the value must be substantiated by an appraisal, and there are specific IRS rules regarding the deductibility of such items. Retirees considering contributing collectibles should consult with a tax advisor to understand the potential benefits and limitations.
       
• Other Complex Assets: Donor-advised funds can accept other complex assets, including oil and gas royalties, life insurance policies, and even certain types of restricted stock. Each sponsoring organization may have different guidelines regarding which assets they accept, so it is important for retirees to work with their provider to determine eligibility.

How Donor-Advised Funds Work

1. Opening a Donor-Advised Fund: The first step is to select a sponsoring organization, which could be a national entity, a community foundation, or a cause-specific provider. Each sponsoring organization has its own guidelines, fees, and minimum contribution requirements. It is important to research and compare these aspects to determine which provider aligns best with the retiree's charitable and financial goals.
       
2. Funding the DAF: Contributions can be made using cash or non-cash assets, such as stocks, bonds, real estate, and even cryptocurrency. Importantly, these contributions are irrevocable, meaning they can only be used for charitable purposes once they enter the DAF. This feature ensures that the funds are dedicated solely to philanthropic activities, which can provide peace of mind for retirees who want to ensure their assets are used for good causes.
       
3. Receiving an Immediate Tax Deduction: Donors can claim an immediate tax deduction for the amount contributed to the fund, provided they itemize their deductions. Contributions of cash are tax-deductible up to 60% of adjusted gross income (AGI), while non-cash assets like appreciated securities are deductible up to 30% of AGI. This flexibility allows retirees to manage their taxable income effectively, especially in years when they may have higher income due to events like required minimum distributions (RMDs) or asset sales.
       
4. Managing Investments Within the DAF: Once in the DAF, funds can be invested, allowing for potential growth that remains tax-free. Donors can select from a variety of investment options offered by the sponsoring organization. This feature enables retirees to grow their charitable contributions over time, ultimately allowing them to make a greater impact on the causes they care about. Investing within the DAF can also help retirees align their charitable giving with their long-term financial plans.
       
5. Recommending Grants to Charities: At any point, donors can advise the fund to make grants to charities of their choice. This flexibility allows retirees to align their charitable giving with personal financial planning and philanthropic goals. Grants can be made to different charities over time, and donors can even choose to make anonymous contributions if they prefer. This aspect of control and flexibility is a significant advantage for retirees who want to be strategic about their giving.

Funding Donor-Advised Funds with Non-Cash Assets

One of the most significant benefits of donor-advised funds is their ability to accept a wide range of non-cash assets. These include publicly traded securities, real estate, private business interests, and even collectibles. Contributing appreciated assets provides a dual benefit:

1. Maximize Deductions: Contributions of appreciated assets are generally deductible at fair market value, up to 30% of AGI. This allows retirees to take full advantage of the value of their assets without having to sell them first, which could trigger capital gains taxes.
       
2. Avoid Capital Gains Tax: Donors avoid paying capital gains tax on the appreciation, which can result in significant tax savings. For retirees who have held assets for many years and seen substantial appreciation, this can be a powerful way to maximize the value of their charitable contributions.

For example, let’s say a retiree owns stock with a current market value of $50,000 that was purchased for $10,000 several years ago. If they donate the stock to their DAF, they can take a $50,000 tax deduction without paying capital gains tax on the $40,000 of appreciation. This approach not only provides a substantial tax deduction but also ensures that the full value of the asset is directed towards charitable causes, rather than being diminished by taxes.

Who Can Benefit from Donor-Advised Funds?

Donor-advised funds can benefit a variety of individual donors in different situations. Here are some examples of donors who may find DAFs particularly useful:

Individuals With Fluctuating Income

For individuals whose income fluctuates year to year, DAFs allow them to reap tax benefits by contributing during peak earning years. A business owner, for instance, could contribute during an exceptionally profitable year to receive a sizable deduction. They could then recommend grants in later years when earnings decrease.

Retiring Individuals

DAFs can benefit retirees who want to engage in strategic charitable giving during their retirement years. They can fund a DAF during their final high-earning years and receive upfront deductions. Throughout retirement, they can then recommend grants based on their available cash flow each year.

Young Professionals

Younger donors may appreciate the ability to open a DAF early on and make ongoing contributions over time. As their account grows, they can make an increasing impact on causes important to them. DAFs provide a turnkey solution to organize one's charitable giving for decades to come.

Families

For families seeking a centralized charitable giving strategy, a DAF provides a convenient solution. Family members can collectively contribute to a shared fund and recommend grants to charities over time. This enables coordinated giving guided by shared priorities.

Donors Making Bequests

Individuals planning a charitable bequest as part of their estate plans may find DAFs to be an optimal tool. They can establish a DAF and name successor advisors to recommend grants from the remaining funds after their death. This creates an ongoing philanthropic legacy.

As you can see, donor-advised funds offer benefits for diverse donors at different stages of life and levels of income. The unifying thread is that DAFs provide maximum tax advantage and strategic flexibility to increase charitable impact over time.

What Types of Charities Are Eligible for DAF Grants?

The charities eligible to receive donor-advised fund grants include IRS 501(c)(3) public charities in good standing. This encompasses a wide range of nonprofit organizations including:

• Educational institutions such as schools, colleges, and universities
• Religious institutions including churches, synagogues, mosques, and religious charities
• Hospitals, medical research organizations, and other health-related charities
• Museums, arts organizations, orchestras, theaters, and other cultural institutions
• Environmental and conservation groups
• Animal welfare and wildlife protection organizations  
• Human services charities benefitting youth, families, the elderly, and more
• International aid organizations providing disaster relief, access to food and clean water, education, and other services

Essentially, public charities recognized as tax-exempt by the IRS are eligible for DAF grants after review and approval by the sponsoring organization. This gives donors the ability to support a diverse range of meaningful causes through their donor-advised fund.

Certain types of organizations are not eligible to receive DAF grants. These include:

• Private non-operating foundations
• Political organizations, candidates, or campaigns
• Nonprofit organizations that have lost their tax-exempt status  
• For-profit companies or entities  
• Crowdfunding campaigns or fundraising platforms

So in summary, a wide array of public charities are eligible for donor-advised fund support after undergoing the sponsor’s review process. This enables donors to recommend grants to the causes that matter most to them.

How to Set Up a Donor-Advised Fund

If you decide a donor-advised fund is the right charitable giving vehicle for you, setting one up is a relatively straightforward process:

1. Choose a Sponsor

The first step is selecting a sponsoring organization for your DAF. You can establish a DAF through community foundations or charitable arms of financial institutions like Fidelity, Schwab, and Vanguard. Consider factors like the sponsor's areas of focus, assets they accept, fees, and level of service.

2. Open an Account

Once you've selected a sponsor, open a DAF account with them. This process is similar to opening a financial account. Be prepared to provide information for anti-money laundering and tax documentation.

3. Make Your Contribution

When opening the account, you will make an irrevocable contribution with the cash, securities, or other assets you want transferred into the fund. Your sponsor will provide instructions regarding asset transfers.

4. Recommend Grants

Once your DAF is funded, you can begin recommending grants! Your sponsor will provide information on their grant recommendation process and timeline.

5. Invest and Grow Your Fund

Work with your sponsor to invest the fund's assets wisely to grow your philanthropic capital over time. Use an investment strategy aligned with your goals for grantmaking.

With these simple steps, your donor-advised fund will be up and running smoothly. You can then begin experiencing the many benefits DAFs provide as your philanthropy gains traction.

Donor-Advised Funds vs. Private Foundations

For substantial donors, private foundations have traditionally been a popular giving vehicle. But in recent years, donor-advised funds have begunrivaling private foundations in popularity due to the distinct advantages DAFs provide:

Lower Costs: DAFs have significantly lower start-up and ongoing administrative costs compared to private foundations. You avoid legal expenses to establish a separate entity.

Less Administration: DAF sponsors handle administrative, legal, and reporting requirements, which are more extensive for private foundations.

Fewer Regulations: DAFs do not require annual tax filings, and they are not subject to strict self-dealing rules or excise taxes applicable to foundations.

Tax Deductions: DAFs allow for larger deductible limits compared to foundations. You can deduct up to 30% of AGI cash donated to a DAF vs. 20% for foundations.

Privacy: DAFs allow for anonymous giving if desired, whereas foundations must publicly disclose grants.

Flexibility: DAFs involve a simpler grantmaking process with greater ability to respond quickly to evolving needs.

While foundations offer total control over assets, DAFs provide a turnkey alternative to make philanthropy easy, accessible, and cost-effective for donors at various giving levels.

Donor-Advised Funds and Direct Giving Compared

Donor-advised funds also provide advantages compared to simply giving directly to charities each year:

Tax Benefits: DAFs provide immediate, upfront deductions vs. deducting gifts annually. You can "bunch" several years' donations to maximize deductions.

Investment Options: Instead of giving cash outright, DAF assets can be invested for potential growth over time.

Consolidated Giving: Rather than managing multiple organizations, giving is streamlined through one centralized fund.

Family Giving Strategy: DAFs allow collaborative giving across generations and naming successor advisors.

Anonymity: DAFs can facilitate anonymous giving to organizations if desired by a donor.

While direct giving provides instant impact, DAFs enable donors to implement a more strategic approach for sustainable, effective philanthropy.

A Case Study: The Benefits of Donor-Advised Funds for Retirees

Case Study: John and Mary Thompson

John and Mary, a retired couple, are long-time supporters of several charities. They recently sold a rental property for a significant gain, which increased their taxable income substantially for the year. To mitigate their tax burden, they decided to contribute $100,000 of the proceeds to a donor-advised fund.

This contribution provided several benefits:

• Tax Deduction: John and Mary were able to claim an immediate tax deduction of $100,000, which helped reduce their taxable income for the year.
       
• Capital Gains Savings: By donating part of their appreciated property proceeds, they avoided paying capital gains taxes.
       
• Flexible Giving: They used their DAF to support their favorite charities over the next few years, allowing them to continue their philanthropy at their own pace without the need for managing individual donations.

^{"This example is hypothetical and intended for illustrative purposes only. DAF are not right for every individual and your specific circumstances may vary."}

Frequently Asked Questions About Donor-Advised Funds

What assets can I use to open and contribute to a DAF?

You can fund a donor-advised fund with cash, stocks, bonds, mutual funds ETFs, restricted stock, private business interests, real estate, art, cryptocurrency, and other assets. Contributing appreciated assets can provide additional tax benefits. Always check on any contribution restrictions your sponsor may have.

How much does it cost to open and maintain a DAF?

Opening a DAF has no upfront costs, only the amount you choose to contribute. Ongoing administrative fees vary by sponsor but average around 0.60% annually. Some sponsors offer fee waivers if your fund balance reaches certain levels. There are no costs to recommend grants.

Can I still advise on grants to charity after I pass away?

Yes, you can appoint successor advisors - such as children, relatives or friends - who can make ongoing DAF grant recommendations after your death. You can also recommend that any remaining funds pay out to certain charities upon your passing.

How quickly can I begin recommending grants after opening a DAF?

You can generally begin recommending grants as soon as the assets transfer into your fund, which typically takes a few days after opening the account. Sponsors will let you know their timeline for evaluating and processing grant recommendations.

Can I still donate directly to charities if I have a DAF?

Yes, having a donor-advised fund does not preclude you from also making direct donations to charities. Many donors give strategically using both vehicles based on the timing of tax deductions needed and assets available.

Utilizing a donor-advised fund can empower you to maximize the difference you make through thoughtful charitable giving. With the benefits, flexibility, and simplicity DAFs provide, it’s no wonder why they are becoming a vital part of many donors' approach to philanthropy in retirement. 

This content is being provided for informational purposes only and should not be construed as specific recommendations or investment advice. Always consult with your investment professional before making important investment decisions. Cambridge does not offer legal or tax advice

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