There are a lot of differing opinions in the FI community–but one thing that everyone can usually agree on is the fact that giving to charity is something that everyone who has the means to do so, should do. People on the path to Financial Independence often want to find a way to donate to charitable causes close to their hearts.With today's higher personal deductions, it's difficult to donate enough to charity to take advantage of the tax deduction. A Donor-Advised Fund allows you to contribute a large lump sum, take the deduction now, and then disperse the funds to charity over time. The account is set up as a 501(c)(3) so contributions are considered charitable donations, but you still control the money and can dole it out as you see fit.
It's an innovative way to donate to charity.
What Is A Donor-Advised Fund?
Put in the simplest of terms, a Donor-Advised Fund (DAF) is an investment account that you contribute to, but all the contributions and profits go to charitable organizations.
But, as I’m sure you’ve guessed, there’s a lot more to donor-advised funds than that. So let's dive a little deeper.
According to the IRS, donor-advised funds are typically held in a 501(c)(3) nonprofit organization. Depending on the brokerage you choose to create the account with, you can contribute cash, as well as other investment assets like stocks and real estate. You decide where the funds go, and when you'd like to disperse them. The brokerage will take care of the actual transactions.
Know that once you've contributed to a donor-advised fund, you cannot take money out of it. The reason being that you get to take the tax deduction as a charitable contribution, so that money is now committed to be donated to a charity.
What Do You Invest In When You Contribute To A Donor-Advised Fund?
What you invest in when you invest in a donor-advised fund depends, of course, on where you open your fund. To give you a sense of what you'll typically end up investing in, for example here's what Schwab Charitable offers:
As you can see, you have plenty of options when it comes to investing your money, from mutual funds to stocks and socially responsible investments.
The Two Major Tax Benefits Of Donor-Advised Funds
Donor-advised funds are popular for many reasons, but their tax advantages are one of the best features of donor-advised funds.
You Get A Tax Deduction
Since the contributions to your fund become a donation to charity, you get a tax deduction, just like you would with any other charitable donation. Since the personal deduction has been increased, it can be difficult to donate enough to charity to qualify for the deduction. Donor-advised funds allow you to group years worth of contributions into one tax year, thereby making it much easier to cross the personal deduction threshold.
The standard deduction for 2019 is $24,400 for married couples. Let's say a married couple pays $900 a month in mortgage interest, gives $500 a month to their church, and has $2,000 in other various deductions. This would bring their total itemized deductions to $18,800. In this case, they would receive a bigger deduction by just taking the standard personal deduction.
However, if they open a donor-advised fund they can contribute several years worth of church donations this year to their donor-advised fund, giving them extra charitable donations they can deduct now.
If they decide to do three years of donations in 2019, they would contribute $18,000 to their donor-advised fund this year. Bringing their itemized deductions up to $30,800. ($10,800 in mortgage interest, $18,000 in charitable donations, and $2,000 in other deductions) This would give them an extra $6,400 in deductions this year.
They can then take $500 a month out of their donor-advised fund and send it to their church monthly over the next three years. Meanwhile, they save the $500 they would have been contributing out of their budget for another big donation in three years. All while taking the standard deduction while they wait.
That is one of the greatest draws of donor-advised funds.
According to the IRS,
If you donate property other than cash to a qualified organization, you may generally deduct the fair market value of the property.
That means you can deduct the value of your donation to a donor-advised fund, although some limitations may apply.
Your Investment Grows Tax-Free
Not only do you get an immediate tax deduction when you contribute to a donor-advised fund, but all of the assets in your account will continue to grow, tax-free.
Donor-Advised Funds Let Small-Scale And Large Investors Invest In A Cause
You'll find that donor-advised funds can have some high minimum deposits, but there are plenty of companies you can house your fund with that don't.
An article in The Atlantic points out the huge benefit of having low minimums for opening a donor-advised fund:
“Another appeal of these funds is that they allow aspiring philanthropists to get started with relatively small amounts of money…This allows champions of donor-advised funds to argue that they result in a quasi-democratization of nonprofit foundations. Foundations are expensive to set up and administer, and experts generally say that unless donors are starting with at least $250,000, most would be better off putting money into a donor-advised fund.”
For budding philanthropists (which many FI-minded folks are,) being able to start a fund for your family's future is reason enough to open a donor-advised fund.
The Negative Side To Donor-Advised Funds
Donor-advised funds sound simple. You contribute money or assets to a company, your investment grows, and when the time is right, you distribute the money to whichever charities you'd like. But there are some reasons that some folks don't love the idea of donor-advised funds.
They Insert A Middleman Into The Giving Process
Some critics of donor-advised funds believe that they create an unnecessary middleman in the giving process. “The Undermining of American Charity” is an in-depth look at the concerns shared by Ray Madoff and Lewis Cullman.
What's the problem with that?
Well, these middlemen require fees, which takes away from the full amount that'll be donated to your choice of charities. And these fees can sometimes be significant. Take, Fidelity for example–they charge a $100 or 0.6% administrative fee on the total balance of your account.
Charities Aren't Getting The Money Right Away
The assets within your donor-advised funds are not immediately distributed to charities–after all, it's meant to grow over time. But Ray Madoff and Lewis Cullman–critics of donor-advised funds–point out:
The funds are […] not just inserting a middleman into the charitable-giving process, but they are also potentially slowing the regular streams of money going from givers to nonprofits.
There's no annual requirement for how much of your money gets distributed to charities, so that means a charity that could use your donation now won't receive it right away. If everyone suddenly started donating to donor-advised funds, charities could stop getting regular donations.
Why Not Just Give To Charity Directly?
So, if donor-advised funds have some serious negatives, why bother with them? Well, there are actually some very good reasons to give donor-advised funds a chance.
Donor-Advised Funds Allow You To Simplify Your Charitable Giving
If you donate to multiple charities, keeping track of the records of your donations can become a pain. Donor-advised funds eliminate the hassle. You can invest money into a donor-advised fund and they'll take care of donating it to all the charities you want.
Contributing to a donor-advised fund can be recorded as one tax-deductible, rather than dozens.
You Can Create A Legacy And Donate
A nice perk of donor-advised funds is that they easily allow you to teach your children about investing and giving at the same time. When your child turns 18, you can give them the ability to share the management of the fund.
Plus, you can name a successor of your fund. So, should you pass away, your children will inherit the fund. In turn, they can name a successor and so on–creating a lasting legacy of charitable giving.
You Can Donate Anonymously
Donating anonymously can be a pain for the charity because they can't seek you out for repeat donations. But, that may also be a draw for you.
If you want to make a one-time donation and prefer not to be called incessantly for donations, a donor-advised fund allows you to donate anonymously. The donation is coming from the fund, not from you directly, so your name isn't associated with the donation.
Where Can I Invest In Donor-Advised Funds?
You'll find donor-advised funds at the bigger investment firms like Fidelity, Schwab, and Vanguard.
Fidelity's Giving Account lets you donate cash, mutual funds, and stocks. Setting up a donor-advised fund with Fidelity is a super simple, entirely online process. The minimum contribution to open an account is $5,000.
Schwab's Charitable Donor-Advised Fund is just as easy to set up as Fidelity's, but with Schwab, you can contribute cash, securities, or appreciated assets. You'll need $5,000 to open an account, and then at least $500 for every contribution after that.
Vanguard's Charitable can be opened online in 15 mins (according to Vanguard.) You can contribute cash or securities and the minimum to open an account is $25,000 and the minimum distribution to a charity is $500.
Donor-advised funds have many pros and many cons, but for some, they're a perfect giving vehicle. If you donate to multiple charities each year, a donor-advised fund can help you stay organized. You can donate cash or assets to the fund every year, and the company you house your fund in takes care of the rest.
Being able to make multiple years worth of charitable contributions at once allows for tax planning that isn't possible without the donor-advised fund.
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