During retirement, you could find yourself with free time and extra money. One way of spending these resources is through volunteering and donating to your favorite charities.
One way of donating to charities is by utilizing a donor-advised fund. The benefits of this method have led this to be one of the fastest-growing methods of donating to charity.
In this article, you will learn:
- What Is a Donor-Advised Fund?
- How Does a Donor-Advised Fund Work?
- What are the Benefits of Donor-Advised Funds?
- Limitations of Donor-Advised Funds
- Choosing the Right Donor-Advised Fund
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.
Setting up your donor-advised fund is like opening a savings or investment account. The most significant difference is that the funds in the account will be earmarked for charity.
Once funds are deposited into a DAF, they cease to be yours. However, as the name suggests, you reserve the right to recommend when and where the sponsor will distribute the funds. According to regulations, the funds must be given to an IRS-qualified public charity.
A key feature of donor-advised funds is that you can distribute the funds out of the DAF to charities over time. While you wait for the right time, you can invest the funds in bonds, stocks, and other investment vehicles.
HOW DOES A DONOR-ADVISED FUND WORK?
Donor-advised funds are simple. However, it can be a bit confusing at first. Here are some of the critical aspects of donor-advised funds that you should understand:
1. SUPPORT THE CHARITIES OF YOUR CHOICE
The first step after opening the account is to transfer assets into your donor-advised fund. Some examples of assets that you can transfer are cash, stocks, mutual funds, and private company stock. Donor-advised funds can only make distributions to IRS-qualified charities for charitable purposes. There are no specific requirements as to when the distributions must take place. You, the donor, can advise that funds be donated to charities at any time. The sponsoring organization will determine whether the charity qualifies as a qualified public charity and that the donation will be used for charitable purposes.
2. GROW YOUR DONATION
Donor-advised funds allow you to distribute your donations over an extended period. Instead of your money sitting idle in the account, you can invest it and potentially grow the amount of money available to give. For this, your sponsoring organization will provide you with a wide range of investment options. They will also help you determine the best investment strategy depending on your objectives.
WHAT ARE THE BENEFITS OF DONOR-ADVISED FUNDS?
Donor-advised funds give donors benefits that they would not have received by just writing a personal check directly to the charity.
1. MAXIMIZE THE POTENTIAL TAX BENEFITS
Now that there is a higher standard deduction, many people do not have enough tax deductions to itemize. By frontloading future yearly donations to charities into the donor-advised fund, donors can get tax deductions for their donations once again. The donor can then distribute the contributions out of the fund as quickly or slowly as they wish.
Another way to maximize tax benefits is by contributing highly appreciated assets to the DAF. By donating the assets directly to the fund, the donor won’t have to pay the taxes that would have been required if they had sold them and then donated the proceeds.
2. EASY TO CONTRIBUTE A WIDE RANGE OF ASSETS
When it comes to donations, donor-advised funds accept both cash and non-cash items.
Some of the asset classes accepted by DAFs include:
- Mutual fund shares and publicly traded securities
- Cryptocurrencies such as Bitcoin, Ethereum, etc.
- Some complex assets, including privately-held S-Corp and C-Corp shares
- Hedge fund interests and private equity
3. PERSONALIZE YOUR CHARITABLE ACTIVITIES
If you have philanthropic interests, a donor-advised fund is a great way to plan such activities. Once you open a DAF account, you can structure it in a way that suits your charitable goals. You may even be able to choose a customized name for your account.
It is also possible to appoint people you trust to help manage the donor-advised fund, including investments and distributions to charity. Your appointees can also ensure that the fund follows your wishes after your death. Donor-advised funds allow for the naming of successor advisors who can recommend grants from the DAF after the original owner's death. You can also set up the DAF so that all remaining money in the DAF pays out to charities you choose after your passing.
4. YOU CAN ENJOY TAX-FREE GROWTH ON THE DONATIONS YOU INVEST
Once you make the initial donation, you can distribute it right away or invest it to possibly have more money to distribute later. The growth in funds invested is tax-free.
LIMITATIONS OF DONOR-ADVISED FUNDS
With donor-advised funds, the primary objective is to provide an easy and more engaging way of donating. The premise is that you have no special interest other than assisting. Therefore, you cannot:
- Make a grant recommendation that can benefit you directly or indirectly
- Support non-IRS-qualified 501(c)(3) organizations such as crowdfunding campaigns, private foundations, and political groups
CHOOSING THE RIGHT DONOR-ADVISED FUND
Once you decide to open a donor-advised fund, you must choose where to set up the account. Sponsoring organizations of DAFs can have their own policies and procedures. It is essential to always ask about services, fees, and any restrictions the sponsor may have.
1. BENEFICIARIES OF THE FUND
Among the nonprofit organizations that sponsor DAFs, there are three primary categories. These categories determine the type of charities they can make donations to. Therefore, the first thing you should do is ensure that your DAF aligns with your philanthropic objectives.
The categories include:
- Single-issue charities- Such DAF sponsors are put in place to fund one charitable issue. Some examples of specific causes are environmental, social justice, and faith-based initiatives.
- Community foundations- As the name suggests, such DAF programs offer charitable support to residents of a specific geographic area. They are generally found in big cities.
- National charities- If you want a greater variety of options for donating, national charities are the ideal option. With these, you can choose almost all public charities across the country.
2. RANGE OF ASSETS THEY ACCEPT
While donor-advised funds generally accept a wide range of assets, not all of them accept every type of asset. So, if you plan to donate a non-cash asset such as cryptocurrency and real estate, confirm if your DAF allows it.
3. INVESTMENT OPTIONS
For long-term philanthropic work, you'll probably want to grow your donation. Enquire from your sponsor about the investment options they offer.
With single-issue and community charities, there can be fewer investment options. You are likely to have more options with the large national charities.
4. ADDITIONAL COSTS AND FEES TO EXPECT
As with any other account that handles funds, you will incur costs. Such fees and expenses include:
- Account management fees
- Investment fees
- Advisor fees
- Other costs
5. THE DAF SPONSOR'S REPUTATION
You've worked hard to get into a position where you can lend a helping hand. So, the last thing you want to do is put your funds at risk. Therefore, even if the DAF has good objectives, you should go a step further and confirm that they have a reliable reputation. You should consider:
- How they operate
- The structure and leadership team
- Whether they have a Form 990 or current audited financial statements
Donor-advised funds are a great way of helping charities while also providing benefits for yourself. The benefits you receive can allow you to give more than you would have been able to otherwise. For these reasons, donor-advised funds are likely to be popular for years to come.
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