Donor Advised Funds: Tax Efficient Charitable Giving

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Donor Advised Funds are a home run strategy for facilitating tax efficient charitable giving and interesting family conversations about money. No wonder they are growing in leaps and bounds. Here are the details you need to know.

With a Donor Advised Fund (DAF), you take cash or appreciated securities that you intend to give to charity and donate them to an account set up in your name under the umbrella of a large non-profit organization, i.e. into your “Donor Advised Fund”. Because you give an irrevocable gift to charity with this transfer, you get a charitable deduction in the year of the transfer. Later that year and/or in subsequent years, you direct the fund to make gifts to the charities of your choice, at the pace you choose. Et voilà – you’ve just separated tax planning from charitable planning.

Why is this separation valuable to you? Think of the times that for tax reasons you’d like to get more deductions into a particular year, e.g. in order to soften the income tax liability triggered by a Roth conversion, or the sale of your business, or from a big bonus, or to muffle the capital gains tax liability from rebalancing your portfolio. In those years, getting a larger than usual charitable deduction could be very appealing.

But tax circumstances have little to do with charitable intentions. They don’t suddenly make you want to quintuple your regular donations. Wouldn’t it be nice to keep the pace of your charitable gifts separated from tax planning? That’s a key advantage of Donor Advised Funds. But there is more.

If you fund your Donor Advised Fund with appreciated securities, you completely avoid capital gains tax liability.

Suppose you bought a stock many years ago for $20 and it is now worth $100. If you sell the stock and give the proceeds to charity, you would first pay capital gains tax on the $80 of appreciation, including $12 for the 15% Federal capital gains tax and $4 for the 5% (assumed net) state capital gains tax, leaving $84 for you to deduct and give to charity.

However, if you give the security directly to a charity, you deduct the full $100. The charity – in this case your DAF – will sell the security and, being a non-profit, will incur no capital gains tax, leaving the full $100 for charity.

It’s true that this tax benefit is available if you give your gift directly to your ultimately chosen charity. However, not all charities are set up to easily receive gifts of appreciated securities. A Donor Advised Trust makes gifts of appreciated securities to such charities quite easy both for you and the charity.

There are several large donor advised funds from which to choose. The most popular are ones established by large financial institutions for example, VanguardFidelity or Charles Schwab.

Each fund imposes its own minimum amounts for initial contributions, subsequent contributions, and for minimum gift amounts, with the low end for these minimums being $5000, $500, and $50 respectively. DAFs provide investment options into which you allocate the funds in your account, just as you do in your 401k plan at work. The DAF will honor your direction for donations as long as the proposed recipient is an IRS-approved charity and if the donation is not in fulfillment of a legally binding pledge. (Best practice is to not use DAF funds for any gift for which you have made a pledge; avoid having to argue about whether or not a pledge is legally binding.)

There are also other Donor Advised Funds to consider, including the large National Philanthropic Trust http://www.nptrust.org/. The first step in comparing Donor Advised Funds is to take a good look at the websites of several funds. Evaluate investment and administrative costs, and specific rules with respect to minimum contributions and donations. Think about administrative ease; transferring assets is easy when your DAF is housed with the same firm as your investment account.

If you have specialized needs, e.g. a desire to donate more complex assets or to donate globally, you’ll probably look beyond the traditional financial firm DAFs. Check out other references such as the short video clips prepared by the National Philanthropic Trust explaining DAFs. http://www.youtube.com/user/NPTrust?feature=watch.

Taking a step beyond tax efficiency and administrative ease, DAFs can facilitate vibrant family conversations about money.

Consider inviting a child to direct a gift from your DAF on the child’s birthday each year.

Imagine a family Thanksgiving conversation if you invite family members to discuss how best to allocate your family’s DAF gifts for that year.

Do your children know what charities you support and why?

Would you and your partner want to celebrate important days with a DAF advised gift?

What would you name your DAF? (Unless you request anonymity, the name of your DAF is what will appear in your charity’s public acknowledgement lists.)

Would the legacy meaning of a DAF make it more palatable for you to trim a concentrated stock position?

And for those thinking about cash flow in retirement, would it be appealing to prefund a DAF while your tax rates and cash flow are relatively high, and so create a personal charitable fund to draw upon in retirement? Creating such a fund presupposes an interesting and ongoing conversation about charitable intent and legacy desires – two issues that are often a central focus in financial planning.

 

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