The Breakdown on Donor Advised Funds

Earlier this week, Giving Tuesday marked the beginning of the most important time of year for non-profit fundraising. At Mana, the holiday season is a time for reflection, gratitude, and giving charitably to causes we care about. We believe in the power of charitable contributions and the donation of our time and services to make the world a better, more livable place. To honor this time of year, we wanted to dedicate this week’s post to a charitable vehicle we spend a lot of time talking to our clients about: the Donor-Advised Fund (also known as a DAF). 

What is a donor-advised fund?

The best way to think about a donor-advised fund is by thinking about it as a charitable investment account. A DAF enables a donor to donate cash, stocks, or non-publicly traded assets such as private business interests, cryptocurrency and private company stock to be eligible for an immediate tax deduction. Once you make the donation, you can’t have the money back. It’s an irrevocable commitment to charity and the assets in the DAF can only be donated to IRS-qualified charities. 

DAFs were conceived by community foundations decades ago. Today DAFs are created or sponsored by a charity. In the 1990s DAFs really took off after a charity affiliated with Fidelity Investments created the Charitable Gift Fund. Today, they are one of the fastest-growing giving vehicles in the United States. According to the National Philanthropic Trust, grants from DAFs to qualified charities totaled an estimated $34.67 billion in 2020, representing a 27% increase from 2019, resulting in the highest increase in DAF grant making in a decade. 

How does a donor-advised fund work?

There are three steps to a well-functioning donor advised fund:

First, you - the donor - contribute personal assets (see the next section for more detail on the types of assets you can donate). This contribution qualifies as an immediate tax deduction. The amount of the deduction depends on several factors, including the type of asset donated and how long you have owned it. 

Next, the assets in the Donor Advised Fund grow, just like they would in any traditional investment account. A nice benefit is that any investment growth is tax-free..

Finally, you can use your assets in the Donor Advised Fund to support the charities you care about. You determine when grants are made. You can opt to make single or recurring grants. 

The 2017 Tax Cuts and Jobs Act made it important for individuals and families to consider charitable bunching - bunching several years worth of charitable donations into one year. This strategy is most advantageous for tax purposes in years where your income is higher than usual, and when your charitable contribution is large enough that you are able to itemize deductions on your tax return. Charitable bunching works well when you know the organization you want to support, and are comfortable making a larger donation in a single year. However, if you’re having a big income year, because your company went public via an IPO, you got a bigger than expected bonus, or had another liquidation event, you may not have had time to consider how you want your resources allocated.  This is where a DAF comes in. You can make a one-time donation, and decide later how you want to allocate your funds to charitable organizations that align with your personal mission.

Why we love DAFs

The primary advantage of a donor-advised fund is the optionality of the assets you can donate. This list includes cash, stock, ETFs, mutual funds, real estate, private S- and C-corp stocks, and non-publicly traded assets such as restricted stock, life insurance, and cryptocurrency. In 2020, Fidelity Charitable reported that two-thirds of contributions were made in non-cash assets, including $28 million of cryptocurrency. 

The added benefit of donating appreciated assets helps donors maximize their contribution to charities, and also offers the perk of avoiding capital gains taxes. Instead of selling your investment, realizing a capital gain, and paying the capital gains tax (which can be up to 20% federal income tax, plus 3.8% net investment income tax, plus state and local capital gains taxes), the full market value of your investment can be donated. This puts more money in the charity’s pocket, and avoids unnecessary donations to the IRS.  

Beyond its timing and flexibility advantages, a DAF provides you with the ability to have a centralized resource for donations, which can help you keep track of the contributions and donations made to charity for tax purposes. Your full donation will be tax deductible in the year it occurs (January 1st through December 31st), and the DAF will produce an easy tax form for you to provide to your CPA or tax preparer. 

A final highlight of DAFs is that they can be invested or re-invested to enable the balance of your charitable contributions to grow as you decide where you would like to donate. Some DAFs even allow for customized management, including socially responsible investing options. This enables you to double down on positive impact through both ethical investing and optimizing your charitable donations. 

The Downsides

A DAF is an actively managed entity that requires bookkeeping, tax reporting, and investment management. As such, these entities have fees associated with their management, including investment fees, and administrative fees. Fees vary by provider, but typically start at 0.60% of investments, or a minimum fee of $150 per year. Additional fees include expense ratios on investments (e.g. exchange-traded fund or mutual funds), and an advisory fee charged by the investment manager. 

While this “downside” is in your control, we think it’s worth mentioning that with DAFs, money stays in an investment account longer as opposed to being donated directly to a charitable organization. If a DAF owner forgets they established this account, or does not create an active giving strategy, money can sit idle, instead of being utilized by a charitable organization. Certain DAF providers have recognized this issue, and have implemented minimum gifting requirements to help mitigate idle funds. In these cases, if an individual does not take any action over a period of time, the account would be liquidated and donated to a philanthropic fund. 

Funding what you believe in

Now that you’ve decided you want to give money to charitable causes, deciding where to donate is the next step. A DAF will ensure that all donations are being made to qualified 501(c)3 charities, helping to reduce the risks of scams or frauds, but we still recommend doing your own independent research. CharityWatch and Charity Navigator are two great websites that provide detailed information on governance of charitable organizations and whether these organizations reach the goals they set out. Smaller organizations may not have a presence on these databases, but you should be able to ask for the non-profit tax return (Form 990) directly from the charity or via Guidestar. If these databases are too overwhelming, or you don’t know where to begin, we put together a list of charities that we love, as a place for clients, readers, and website visitors to get started.

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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.