Planning With A Donor Advised Fund

For many families, charitable giving is both a financial strategy and a way to express deeply held values. A Donor-Advised Fund (DAF) is one of the most flexible and tax-efficient tools available for people who want to make a lasting charitable impact—while also realizing meaningful tax benefits.

Below we’ll break down why and how a person would establish a donor-advised fund, the advantages, and the potential issues to consider at both the federal and state levels.

What Is a Donor-Advised Fund?

A donor-advised fund is a charitable giving account established under the umbrella of a public charity, such as a community foundation or the charitable arm of a financial institution (e.g., Fidelity Charitable, Schwab Charitable, Vanguard Charitable, etc.).

You contribute cash, securities, or other assets to the fund and immediately receive a charitable income tax deduction. The fund itself invests the assets, allowing them to grow tax-free over time. You, as the donor, then “advise” when and how grants should be distributed to your favorite qualified charities.

In essence, a DAF functions like a personal charitable foundation—but without the administrative burdens or cost.

How to Set Up a Donor-Advised Fund

1. Select a Sponsoring Organization
   Choose a public charity that offers DAFs. Many large financial institutions and local community foundations have well-established programs.
2. Contribute Assets
   You can contribute cash, appreciated stocks, mutual funds, real estate, or even cryptocurrency. The sponsoring organization liquidates and manages these assets.
3. Receive an Immediate Tax Deduction
   You receive a federal income tax deduction in the year of contribution, even though grants may be made later.
4. Advise on Investments and Grants
   You can recommend how funds should be invested and which qualified charities should receive grants—either immediately or in the future.
5. Name Successor Advisors
   You can designate children or other family members to continue the charitable legacy after your lifetime.

Federal Tax Benefits

1. Immediate Income Tax Deduction:
Contributions to a DAF qualify as charitable gifts to a public charity, so you can generally deduct up to 60% of AGI for cash and 30% of AGI for appreciated assets, with a five-year carryforward for unused deductions.

2. Avoidance of Capital Gains Tax:
When you donate appreciated stock or property directly to a DAF, you avoid paying capital gains tax on the appreciation, allowing the full fair market value to be used for charitable purposes.

3. Tax-Free Growth:
Funds in the DAF grow tax-free, enabling larger future gifts.

4. Estate Tax Efficiency:
DAFs can reduce the size of your taxable estate if established during life or by testamentary transfer.

State Tax Considerations

State income tax deductions vary:

• Some states (like Missouri and Illinois) follow federal charitable deduction rules for taxpayers who itemize, but if you take the standard deduction, state-level benefits may be limited.
• Timing matters—because your deduction applies in the year of the contribution, not when grants are made, it can be an effective strategy for offsetting large income years (e.g., after selling a business or property).
• Estate and inheritance tax implications differ by state; while the DAF contribution typically removes assets from your estate, coordination with your estate plan and trust documents is crucial.

Key Benefits of a Donor-Advised Fund

• Simplicity: Easier and cheaper to administer than a private foundation.
• Flexibility: You control the timing of gifts and can involve your family in giving decisions.
• Privacy: Unlike private foundations, DAFs don’t require public reporting of grants or donors.
• Legacy: You can name successors to continue charitable giving in your name.
• Strategic Bunching: Donors often “bunch” several years’ worth of charitable gifts into one year to maximize itemized deductions while using a DAF to smooth giving over time.

Common Issues and Limitations

1. Loss of Control:
   Once contributed, the funds legally belong to the sponsoring charity. You can only recommend distributions.
2. Investment Restrictions:
   Investment options may be limited to pre-approved portfolios offered by the sponsor.
3. No Gifts to Individuals:
   DAFs can only grant to IRS-qualified 501(c)(3) charities—not directly to people, political causes, or private benefit organizations.
4. Administrative Fees:
   Sponsors typically charge annual administrative or management fees, which can reduce returns on smaller accounts.
5. Perception of “Parking Funds”:
   Critics argue that some DAFs hold funds indefinitely instead of distributing them promptly to active charities. The IRS may eventually tighten distribution requirements.

When a Donor-Advised Fund Makes Sense

A DAF can be a powerful tool if you:

• Experience a high-income year (e.g., sale of a business, large bonus, retirement payout);
• Hold highly appreciated assets you want to give without triggering capital gains;
• Want to simplify long-term giving or create a family legacy of philanthropy;
• Seek to centralize charitable records and distributions.

Final Thoughts

A donor-advised fund bridges the gap between charitable intent and financial strategy. It allows you to make meaningful gifts, enjoy immediate tax benefits, and support your favorite causes over time—with a fraction of the complexity of running a private foundation.

However, as with any charitable vehicle, proper planning and coordination with your estate, tax, and investment advisors is critical. Missteps in timing or contribution type can dilute the intended tax benefits.

If you’re considering establishing a DAF, an experienced estate planning attorney or tax professional can help align it with your overall financial and legacy plan.