8201 Preston Road,
Americans have always been very charitable, but in this Information Age, donors are demanding more accountability, transparency, and individual choice, so that their philanthropic dollars are truly being used well. This is evidenced by the $37M raised in one day this year by individuals through North Texas Giving Day, a “day of giving” event hosted by Communities Foundation of Texas (CFT).
I work with high net worth investors, families, and small business owners, so I have frequent discussions about charitable giving. What I often find is that the donor makes a heartfelt decision to donate in order to achieve a greater good, but each decision is made “one-off” and not as part of a greater strategy tailored to what the donor wants to achieve. So how do donors make their charitable choices more personalized, and possibly more meaningful over the long-term? Donor Advised Funds (DAFs) offer one excellent solution, and have gained popularity in recent years.
What they are:
Donor Advised Funds are private giving accounts held at a public charity.
How they work:
Sally Smith opens a Donor Advised Fund at a public charity. The fund is named after Sally:
The Sally Smith Fund at the Communities Foundation of Texas
Sally donates $25k in cash and shares of her company stock to the Fund. She receives a tax deduction in the calendar year that she makes the donation to her Fund. However, the dollars stay in the DAF until Sally tells Communities Foundation of Texas where to send it. If Sally can’t make up her mind before the holidays, no distribution is made. In the following January, she has the time to work on her philanthropic goals and decides to make distributions from her fund to fight heart disease and to protect children. Part of the benefit of working with Communities Foundation of Texas is that they have already run the due diligence on local programs, and they guide Sally where she can direct her donation to achieve her goals. She then makes a $5k distribution from her Fund to two charities. She does not receive an additional deduction at the time of the gift since she already received the deduction the previous year. If she does not make any additional gifts this year, she will have $15k left in her fund to spend when the time is right. She can make an additional contribution this year, or she can choose not to do so.
Aside from the control that DAFs provide, they have other unique features which make them very appealing to a wide variety of donors:
DAFs can be started with a small level of funding, sometimes as low as $5-10,000. This allows people of mid- to upper- income levels to control and direct their funding.
DAF tax deductions can be maximized and specified. DAF donations qualify for the highest tax deduction (50% AGI tax deduction limit for cash, 30% AGI tax deduction limit for long-term capital gain property). Private foundations have a lower limit on both types of contributions. Additionally, just as we saw with Sally, you can receive the tax deduction in one year and choose where the money goes in a different year. If you donate directly to a charity, the donation and the gift happen in the same year.
DAFs have standardized administration. Since the DAF is held by a public charity, the charity handles the administration of the fund. While you will pay a fee for this administration, it is likely to be less expensive than setting up a charity on your own. The old world way for a donor to control their charitable dollars was to establish a private foundation, which is still an option. However, a private foundation is a separate tax entity, has very specific requirements regarding governance, and is much more intricate than a DAF. Private foundations work well for very high levels of giving across multiple platforms and generations. A good example of this is the Bill and Melinda Gates Foundation.
The DAF that holds your fund will also invest your funds for you, and growth is tax-free.
Even more important, the charity will perform due diligence on the charity where your gift will ultimately be made. They keep track of your donations, so it is a “one stop shop” for a comprehensive giving strategy.
DAFs can be established by individuals, families, or companies. Large corporations have entire departments that direct their philanthropic giving. Smaller companies may not have the staff to be able to direct the company’s “giving back” strategies. Creating a company DAF allows the company to donate when the time is right, and to designate where the funds go at a later point in time, if appropriate.
Donor-advised funds may also be a great answer for those who don’t want to leave their estate to people. We see this with clients who have no children, and those whose children are financially successful. Instead, they want the funds to be used for the good of the community. The Communities Foundation of Texas, for example, works with their donors on a giving plan for how the funds would be distributed after the donor dies, providing both flexibility and guardrails.
DAFs are very flexible in the assets that can be donated. While you will need to verify the list of assets with the organization providing the DAF, part of the reason that they are so appealing is that you can donate cash, investments that you own, shares of a closely held company, or real estate.
This is a key consideration for those who are selling an asset that has significant appreciation (a business, a vacation home, a long-term stock holding) and want to make a gift now or in the future. Let’s go back to Sally as an example. If she bought the company stock (outside of a retirement plan) for $50,000, and it is now valued at $80,000, she would have a capital gain of $30,000. While capital gain rates vary, if Sally pays a capital gain tax at a rate of 20%, she will owe Uncle Sam $6,000. Instead, she donates the stock to CFT and avoids the taxes, which allow her to make a larger donation than she would have if she sold the stock and donated cash. This same process holds true for real estate with a large gain. While this tax strategy is also true of donations made directly to a charity, many local charities accept only cash.
As with all things that relate to your money, you should perform your own due diligence before making a decision about whether a DAF is a good strategy for you or not. It is also imperative that you work with a reputable public charity that will take care with the administration of your funds. And if you are considering using a DAF to handle your estate, you want to work with a charity that will be around long after you will.
Many cities have a Communities Foundation, so you can check with your local organization first. There also may be other large charitable organizations in your hometown that offer DAFs. Some investment companies provide this service as well.
In the interest of full disclosure, my husband and I have a family Donor Advised Fund at the Communities Foundation of Texas. Part of the reason we started the fund is to involve our children in the giving process. They are decision makers on the fund with us, and they participate in the meetings we have regarding how we donate to our donor advised fund, and how we distribute money to help our community each year.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. Federal tax laws are complex and subject to change. Neither FSC Securities Corporation, nor its registered representatives, provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.