Using donor-recommended funds is a more advanced tax strategy that has recently become more popular with the introduction of the Tax Reduction and Employment Act (TCJA) in February 2020. The TCJA nearly doubled the amount of the standard deduction, making it less beneficial to listing deductions such as charitable donations. For people with a large number of charitable donations, donor-recommended funds are an option to continue receiving a charity donation allowance.
What is a Donor Advised Fund?
A Donor Advised Fund (DAF) is a 501 (c) (3) registered not-for-profit organization that accepts contributions and generally funds other not-for-profit organizations. While the concept of a donor-advised fund has been around for nearly 100 years, they have typically only been used by the ultra-rich. While donor-recommended funds will still not be of use to the vast majority of people, recent changes in tax law have increased their use.
You can set up a donor-recommended fund with most brokers including Fidelity, Vanguard, and Bank of America. You can donate cash, stocks, or other types of assets to the DAF. The exact list of donated assets depends on the broker. After you've made a contribution, you can use the funds in your account to make donations to charity.
You can maximize your charity tax deductions in a year
A common reason people set up donor-advised funds is to maximize their charitable tax deductions in a given tax year. To show why this can be beneficial, I'll use an example:
Our sample family files their taxes together and has regular donations of $ 20,000 per year. The 2020 standard deduction for registering a marriage together is $ 24,800. Because their amount of charitable deductions is less than the standard allowance, they may not see a tax benefit on their charitable contributions (depending on the amount of other recognized deductions). In 2021, they again plan to donate $ 20,000 to nonprofits and it is unlikely to result in a tax break.
Now consider that in 2020 the same family will decide to set up a donor advised fund. You have additional money in low-interest savings or current accounts or in a taxable investment account. So in 2020 they set up a donor-advised fund and funded it with $ 40,000 in cash, stocks, or other assets. You are eligible to use the full $ 40,000 as a single deduction even if you only use $ 20,000 to donate to a charity of your choice. Then they can donate the remaining $ 20,000 to their preferred charity in 2021. You will not be able to deduct any charitable donations in 2021, but will instead be able to claim the increased standard deduction amount.
You may be able to deduct the full value of stocks or other investments
Another reason you might want to set up a donor-recommended fund is because you may be able to withdraw the full value of stocks or other investments. I'll use an example again to illustrate the point.
Let's say you have stocks that you bought for $ 20,000 that are now worth $ 50,000. Many charities, especially smaller organizations, are not set up to accept stock donations or other investments. So if you want to donate that $ 50,000 to charity, you may have to liquidate your stocks. This means that you will have to pay tax on the proceeds.
With a fund recommended by donors, you can donate the shares to your fund and deduct the full market value of your shares. Then the fund can contribute to a charity of your choice.
Donate a wide variety of assets
Another benefit of setting up a donor-advised fund is the ability to donate a wide range of different classes of assets. As mentioned earlier, many charities are not set up to accept donations in kind. While the exact list of assets a donor-recommended fund can accept varies from the company managing the fund, it generally includes more types of assets than a typical charity.
Why might you not want to set up a donor-recommended fund?
There are many benefits to setting up a donor-recommended fund, but there are a few things to look out for.
It's definitely more complicated than just making charitable contributions. The tax savings may not be worth the extra hassle.
On top of the added complexity, most companies with DAFs charge management fees that can lower your ROI.
You may be limited to the charities you can donate to. Each donor-advised fund usually has a list of eligible charities. You may find that a charity you want to donate to is not available.
You will also lose control of the donated funds. The donation to the fund is irrevocable. So once you donate to the fund, you cannot get the donation back. While most counselors state that they will donate the money on your instructions, they are not required by law to do so.
The money in a DAF is invested so it can depreciate in value. This means that the amount you tried to donate may be less than expected. Typically, you will also have a limited choice of investments and these funds will often incur fees.
It is also important to note that the annual income tax deduction limits for gifts to donor advised funds are 60% of Adjusted Gross Income for cash contributions and 30% of AGI for contributions in kind eligible for investment income tax treatment ;; 50% of AGI for mixed contributions of cash and in kind.
Dan Miller (42 posts)
Dan Miller is a freelance writer and founder of PointsWithACrew.com, a website that helps families travel for free / cheap. His home base is in Cincinnati, but he tries to travel the world as much as possible with his wife and 6 children.