A donor-advised fund, or DAF, is a tax-advantaged vehicle for charitable giving. Individuals, families, and organizations can establish donor-advised funds to further philanthropic efforts while supporting their favorite charities.
Here’s a closer look at what a donor-advised fund is used for, the pros and cons, and how to create one.
Key Points
• Donor-advised funds (DAFs) are charitable giving accounts, administered by sponsors, that allow donors to make tax-deductible donations that can be gifted to charities at a later time.
• DAFs can be established by individuals, families, trusts, corporations, estates, and foundations.
• Contributions to DAFs may include cash, stocks, real estate, cryptocurrency, and more.
• DAFs offer flexibility in charitable giving, allowing donors to recommend how funds are used and invested.
• Potential disadvantages include lack of donor control, fees, and the irrevocability of contributions.
What Is a Donor-Advised Fund?
A donor-advised fund is a separately identified fund or account that exists for the purpose of making charitable donations to eligible organizations. In effect, they’re a sort of charitable investment account. They’re important funding sources for nonprofits that rely on public support via donations or charitable giving.
Donor-advised funds may be established by:
• Individuals and families
• Trusts
• Corporations
• Estates
• Foundations
Multiple donors may contribute to a donor-advised fund, and a third party, (or, the sponsor) administers and oversees it – hence the “donor-advised” moniker. This third party is responsible for making grants to eligible charities from donated funds.
Definition and Purpose
A donor-advised fund, most simply, is a private investment account that’s used exclusively to make charitable donations.
Donor-advised funds may be established to support a variety of 501(c)3 organizations. A 501(c)3 is a tax-exempt organization, as defined by the Internal Revenue Service. Examples of organizations that are supported by donor-advised funds could include:
• Colleges and universities
• Hospitals and healthcare organizations
• Religious organizations
• Animal welfare agencies
• Humanitarian organizations
• Environmental charities
• Disaster relief organizations
Under the Internal Revenue Code (IRC), tax-exempt purposes include “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
Key Players Involved
The key players in a donor-advised fund are the sponsors, donors, and charities that receive donations. More specifically:
• Sponsors are the organizations that administer the fund.
• Donors are the individuals or entities who make contributions to the fund.
• Receiving charities are eligible nonprofits, as defined by the IRS, per the information above.
When you make contributions to a donor-advised fund, the sponsor manages them on your behalf. You can request which charitable causes to fund with your donation — though this may ultimately be decided by the sponsor — and when donations should be distributed.
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Benefits of Using a Donor-Advised Fund
You might wonder why someone would establish or contribute to a donor-advised fund when they could make direct charitable contributions to an organization instead. Answering that question is easier when you consider the benefits offered by donor-advised funds, which can include tax advantages, flexible giving, and more.
Tax Advantages
A donor-advised fund offers an immediate tax deduction for contributions. The deduction applies whether you donate cash or another type of asset, including publicly-traded securities, like stocks.
You’ll need to itemize deductions on the Schedule A tax form to write off donations to donor-advisor funds. That’s one of the main things to know about charitable donations and taxes.
For 2024, the charitable deduction limit is as follows:
• Up to 60% of adjusted gross income (AGI) for cash donations
• Up to 30% of adjusted gross income (AGI) for noncash donations
Deductions reduce your taxable income for the year. Claiming deductions for donor-advised fund contributions could help push you into a lower tax bracket when it’s time to file your return.
Flexibility in Charitable Giving
Donor-advised funds allow for flexibility in deciding where your donations may go. While the sponsor has legal control over assets in the fund, donors can make recommendations on how the funds should be used.
You can make contributions at your own pace, and you can choose the recipient charities at a later time. Donor-advised funds may accept a variety of financial gifts, including cash, stock, real estate, and even noncash or alternative assets, such as cryptocurrency.
Investment Growth Potential
Donor-advised funds give donors a different avenue through which to make investments, and to provide some guidance about how money in the fund should be invested. Investment growth within a DAF is tax-free, so every additional penny your money earns can go directly to the charity or charities you prefer. Note that some DAFs may require regular distributions of funds, which can influence how long assets have to grow.
Potential Disadvantages of Donor-Advised Funds
Donor-advised funds can have drawbacks, both for donors and for the charities that receive donations through them. The main drawbacks for charities are a lack of transparency surrounding donations and potential delays, should donors choose to allow contributions to grow before funds are released. Further, donor-advised funds have been criticized as a tool that can be used by the wealthy to secure tax advantages – the IRS, in recent years, has released new regulations to mitigate that sort of potential abuse.
For donors, the disadvantages can include:
• Lack of control: While donors may make recommendations about investments or which charities should receive funds, the sponsor has the final say.
• Fees and minimums: Donor-advised funds can charge annual fees and other fees, which donors are responsible for paying. Some funds may require a minimum contribution of $1 million or more.
• No reversals: Once you contribute to a donor-advised fund the money must remain in the fund until it’s disbursed to charity. You can’t make a contribution and take it back later.
Setting Up and Contributing to a DAF
Setting up a DAF is simple enough. You need to find a sponsor, open your account, and make a contribution. Here’s more on how the process works.
Choosing a Sponsoring Organization
Several types of organizations can sponsor donor-advised funds, such as public foundations and 501(c)3 organizations associated with a brokerage.
Your goals related to charitable giving may determine which option you choose. If you’re primarily interested in funding local charities, for instance, you might select a community organization that administers a donor-advised fund. On the other hand, if you’d like to have access to a wider range of charities you might consider a DAF offered in association with a brokerage.
Opening an Account
You’ll need to complete the necessary paperwork to open your account once you’ve selected a sponsoring organization. Along with your personal information, you may need to specify, among other things:
• Which charities you’d like to support
• How you’d like contributions to be invested
• The identity of the sponsor
Once the paperwork is complete you can move on to the final step, and begin funding your account.
Contribution Types and Limits
You can decide what form your contributions to a donor-advised fund should take. The options can include, but are not limited to:
• Cash
• Stocks, bonds, and mutual funds
• Traditional IRA or 401(k) assets
• Cryptocurrency
• Real estate
• Private business interests
The fund sponsor should be able to tell you what the minimum contribution is (often around $5,000), if any, and whether there’s any upper limit on how much you can contribute annually. Keep in mind that with any contributions you make, you can only deduct them up to the limit allowed by the IRS.
Donor-Advised Fund vs. Private Foundation
A private foundation can be another vehicle for making charitable donations. Private foundations are 501(c)(3) organizations, and can be established by corporations, but they’re often used by families and wealthy individuals to fund philanthropic activity.
There are several differences to note between the two.
| Donor-Advised Fund | Private Foundation |
|---|---|
| Donors make recommendations about how contributions to the fund should be invested and distributed to charities. | Donors have more control of investment decisions and how contributions are distributed. |
| Cash donations are deductible up to 60% of AGI; noncash donations are deductible up to 30% of AGI. | Cash donations are deductible up to 30% of AGI; noncash donations are deductible up to 20% of AGI. |
| No annual payout is required. | Minimum annual payout of 5% of net asset value is required. |
Generally speaking, a donor-advised fund usually requires less paperwork and is less costly to establish. It’s also easier to maintain privacy, since you can keep your name as a donor confidential if you prefer. Private foundations, on the other hand, are more time- and cost-intensive to create. Privacy is limited as foundations are required to file public tax returns.
In terms of the difference between nonprofits vs. foundations, they can both be established as tax-exempt, 501(c)3 organizations. However, nonprofits and foundations may have different underlying goals, tax implications, and more.
The Takeaway
Donor-advised funds can offer an avenue for giving if you’re looking for charities to support. You’ll need to have sufficient capital to make an initial contribution but the tax advantages can be substantial. And you can still make contributions directly to qualify for a tax break if you don’t meet the minimum requirements for a DAF.
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FAQ
Are donations to a donor-advised fund tax-deductible?
Donating to a donor-advised fund allows you to qualify for an immediate tax deduction. You can deduct cash donations up to 60% of your AGI, or noncash donations up to 30% of your AGI.
Can you name a successor for your donor-advised fund?
Yes, you can name a successor for your donor-advised fund. You may be prompted to do so at the time that you open your account and complete the initial paperwork. A successor essentially inherits the fund from you when you pass away.
What are the typical fees associated with a donor-advised fund?
Donor-advised funds can charge annual or administrative fees. These fees are typically assessed as a percentage of your account balance. The higher your balance, the lower the fee might be.
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