Donor-Advised Funds: Their Place in Today’s ClimateAnchin Private Client CenterJune 30, 2020
In this unprecedented time, citizens have been quick to expand their philanthropic focus and do whatever they can to help those hit hard by the COVID-19 pandemic and its financial fallout.
The pandemic, and the philanthropic world’s response, has put one option in the spotlight: Donor-Advised Funds. While DAFs, as they are commonly known, have been a relatively small part of charitable giving, they have gained popularity for their combination of tax benefits and philanthropic good. In fact, their popularity has skyrocketed in the past few years, as their presence is indicated among the Chronicle of Philanthropy’s ranking of charities receiving the most in private dollars.
Today, DAFs represent one of philanthropy’s fastest-growing vehicles. Grants from donor-advised funds now account for more than 3 percent of all giving in the United States.
A donor-advised fund can be thought of as a personal charitable savings account. The donor first creates the account and contributes any combination of cash, equities, cryptocurrency and other tangible assets, such as art or real estate. The donor can take an immediate tax deduction for the gift(s), while the account is controlled by a nonprofit, which must be a public charity. This “sponsoring organization” invests the donor’s contributions and makes payments to qualified charities (which are generally other 501(c)(3) public charities), based on donor recommendations.
Typically, DAFs are paying out on an annual basis an average of 20% of their total funds, and recent statistics show that they have stepped up in light of current events and are trending towards 30%. Based on this increase, billions in additional funding may move to nonprofits from DAFs this year. Critics of DAFs argue that a minimum annual distribution should be required, such as the 5% minimum requirement for private non-operating foundations. Some are worried that a 5% obligation would drop the average payout due to a propensity to meet minimum requirements. While DAFs are making their mark in the philanthropic world, it’s best to know the benefits and other considerations before diving in.
Donor-advised funds can be a smart way to reduce your tax liability, and not mitigate your charitable giving.
- Immediate Tax Deductions. When you place cash and other assets into a DAF, you can take any qualified deductions in that year. Donors receive an immediate tax deduction of up to 60% of adjusted gross income for cash gifts and a fair market value deduction of up to 30% of adjusted gross income for contributions of appreciated securities, mutual funds, real estate and other assets, and can enjoy a five-year carry-forward deduction on gifts that exceed AGI limits. Additionally, it may be valuable to bundle or clump charitable deductions to qualify to itemize deductions in a year where you would otherwise be limited to the standard deduction.
- Giving Flexibility. While you can take immediate tax deductions, you and the sponsor can still be deliberate and thoughtful with gifts. DAFs allow the money to grow tax free until you’re ready to make a payout to a qualified charity. The donor retains advisory privileges on how the money is invested, and which charities receive the contributions. Some DAFs allow a fund to be divided into smaller funds in order to accommodate multiple children, who can be advisors for their designated fund. Yet another option, if the fund is not divided, is to have children serve on a team of advisors with one designated spokesperson. Some DAFs have a minimum age requirement in order to have advisory privileges.
- Eliminate Capital Gains. When you transfer such assets as appreciated equities (which have been held for at least a year) right into the fund, you are not liable for any capital gains and their associated taxes. In comparison, if one were to sell equities and then donate the money to a fund, they’d be hit with a pretty hefty capital gains tag (as high as 23.8% for Federal taxes, factoring in the tax on net investment income as well as any state and local taxes), leaving less money available for giving.
- Lessen a Tax Liability from a Windfall. DAFs can help mitigate any tax burdens that come with an expected, or unexpected, windfall. If you have received an inheritance, have seen tremendous investment returns or are selling a business, you know that the government will have its sharp eye on their share of the tax pie. DAFs allow you to receive immediate tax benefits by contributing these assets and still schedule the giving on your time in accordance with the plans of the fund sponsor.
- Philanthropic plan for donating over the years. Sponsor organizations have a good understanding of nonprofits and offer services such as family philanthropic consulting.
Disadvantages and Other Considerations
- Control Over Assets is No Longer Yours. Even as the funds grow tax-free, the sponsor of the DAF has legal control of the fund assets and has final say in charitable disbursements. While most plan sponsors will take your wishes into account, this is not guaranteed.
- Money is Not Donated Immediately. You may want the assets in a DAF to be donated to a specific charity right away; again, most sponsors will heed your wishes, but it’s not mandated. They have the last say on when, where and how much.
- Watch Out for Fees and Minimums. To set up a DAF, some large institutions will require a minimum donation, ranging from $5,000 to $25,000. Also be prepared to pay annual administrative fees based on the value of the fund assets. While these costs are not extreme, they can add up.
- Preset Investment Options. When you cede control of the funds, you also give up some say as to where they are invested. While you may have an opinion on the aggressiveness of the style, the specific investment vehicles are usually made from a menu of pre-selected options.
- Limitations related to asset types. Keep in mind that some sponsors have limitations on the type of asset that they will receive. Some may exclusively take cash and appreciated securities, for example. If you have unique assets, you should plan ahead.
- DAF sponsors have varying treatments for succession. Another factor when considering a DAF is succession planning. Some allow DAFs to be passed down through generations without restriction. Others mandate that the remainder of the funds upon the death of the donor be donated to a designated charity.
- Keep in mind that in 2020, other options will have greater tax benefits. Another consideration is that under the CARES Act, if you give cash contributions to 501(c)(3) public charities, you can get a deduction of up to 100% of adjusted gross income. However, DAFs are not considered qualified organizations for this purpose.
If you would like to discuss any aspects of a Donor-Advised Fund, contact your Anchin relationship partner or Barry Lieberman, a member of Anchin Private Client at 212.840.3456 or firstname.lastname@example.org.