What in the World is a Donor- Advised Fund (DAF)?
by Randy Kaufman
with research assistance from Dustin Lowman
No shortage of research has been conducted on the relationship between money and happiness.
One of the most interesting and important findings has been that things — material possessions — don’t have much of an impact on a person’s happiness.
Experiences, on the other hand, do. One of the experiences most closely tied with happiness is philanthropic giving.
Giving away money is easy. But giving well is hard. Giving in a way that has a real, positive impact — even harder. As Dale Carnegie famously said, “It is more difficult to give money away intelligently than to earn it in the first place.”
One of the most common mistakes people make with philanthropic giving is doing it solely for the tax benefit. Just like we advise people to buy homes only when they really want to live there, we advise people to give philanthropically when they feel strongly about a cause. Once people have a good reason for giving, there are certain strategies that help maximize its tax efficiency.
One such strategy that we often recommend is setting up a Donor-Advised Fund (DAF). A DAF is a private fund managed by a third party. Its express purpose is to collate funds for future charitable donations. You immediately get a tax deduction when you set up a DAF. After setting it up, you can use a DAF to make charitable contributions. That way, you reap an immediate tax benefit without having to donate to a specific organization right away. You can wait to send funds until you find the right organization.
If giving well is part of your financial objectives, you might consider setting up a DAF, especially in a year when you have a lot of taxable income. In this article, we’ll explore how they work, what makes them compelling, and what you should do if you’re interested in setting one up.
How Donor-Advised Funds Work
Individuals (often working in concert with their financial advisors and accountants) set up DAFs through sponsors who invest and nurture the funds. There are three key types of sponsoring organization:
National Fund Providers — The charitable segments of financial service institutions like Schwab and Fidelity
Community Foundations — Public charities that often focus on supporting specific geographic regions
Single-Issue Charities — Fund providers operating in a specific area, like education or religion
After selecting a sponsor, individuals make an “irrevocable contribution,” which can consist of a wide range of asset types — cash, securities, property, even artwork.
Unlike the “checkbook giving” that tends to mount around the holidays, DAFs present no pressure to turn those contributions into actual charitable gifts. In fact, in most circumstances, you can deduct the amount of the contributions immediately. (Please note that this, like most tax issues, can be complicated and must be checked with your accountant.) If you desire, you can let the assets grow like they would in any investment account before making grants. The one rule is that the assets can only be used for future charitable giving.
Some other key features of DAFs include:
Custom Appointees. If you want, you can name certain trusted associates (family members, friends, advisors) to help you handle the work of a DAF.
Create Investment Recommendations. Like any investment account, you’re part of the conversation when it comes to allocating assets. If you want to avoid certain sectors, you can make those recommendations to your sponsor.
Design a Legacy. In addition to making an impact while you’re alive, you can set instructions for what will happen to the DAF when you pass on, and you can involve your children now in the decision making, in order to train them, and, in my experience, learn from them as well.
Other Benefits of Donor-Advised Funds
Good data allows you to make good decisions; spotty data has you shooting in the dark. Keeping track of when you give, how much you give, and why you give/stop giving is a hard task. DAFs collect all of this information in one place, thus making it easy to navigate at year’s end.
It’s also extremely easy to donate stock to a DAF. When you donate appreciated stock to DAFs, neither you nor the charity pays any capital gains taxes. Under normal circumstances, if you sell $1,000 worth of Amazon stock that has a cost basis of $200, you would pay $160 in capital gains tax (assuming the highest rate) and keep $840. If instead, you transfer that same $1,000 of Amazon stock to your DAF, the DAF sells it tax-free. In effect, you’ve reallocated money from the IRS to your favorite philanthropic cause.
Plus, with “Bunching,” you can exceed the standard $10,000 cap on charitable tax deductions. Often, advisors recommend making several years’ worth of charitable contributions to a DAF in one year, indirectly enabling several years’ worth of tax deductions.
Interested in Setting Up a Donor-Advised Fund?
Setting up a DAF is an excellent solution for people at all stages of their philanthropic lives. Especially if you’re just starting out, it’s prudent to earmark funds for charitable causes and let the assets grow over time.
With any complex topic, it’s rare that we have all the answers, right away. Philanthropy is no exception. DAFs allow you to reap the upside and take the time you need to make careful, intentional grants.
Interested in learning more? Schedule a free discovery session today!
Randy Kaufman is a Wealth Advisor at Heron Wealth. Her expertise includes estate and income tax planning, pre-deal planning, multi-generational issues, impact investing, and philanthropy.
Previously, Randy was a Senior Vice President at EMM Wealth and a Partner at Cerity Partners. She also she worked at Evercore Wealth Management as a Wealth Advisor, and at Federal Street Advisors, where she managed the firm’s Family Office Services. Randy also spent seven years at LongVue Advisors, a multi-family office that she co-founded, and six years with Fleet Bank and its predecessor, BankBoston, where she was the founder and managing director of the Wealth Strategies Group in Fleet Bank’s Private Client Group. Before becoming a wealth adviser in 1998, Randy held various investment banking and tax structuring positions