What You Should Know about Donor-Advised Funds (DAFs)
By Nicole Young on November 28, 2023
Donor Advised Funds (DAFs) Explained
Charitable giving represents an opportunity to champion the causes you believe in while also earning tax benefits and building your legacy. For these reasons, it’s a pillar in many Americans’ financial plans. In fact, recent years have seen sharp increases in giving as donors have reaffirmed their commitment to supporting nonprofit organizations.1
Whether you’re a longtime donor or giving for the first time, you may be wondering how best to deploy your capital. A Donor Advised Fund (DAF) can help you structure your philanthropy for tax management purposes while growing the impact of your giving. Here’s what you should know about DAFs.
What is a Donor-Advised Fund?
A DAF can be thought of as a type of investment account that exists purely for giving purposes. Much like a retirement or college savings account, a DAF allows you to grow your contributions in a tax sheltered environment until you’re ready to give to the nonprofit organization of your choice. Furthermore, when you contribute cash, securities, or other assets to a DAF, you are eligible for a tax deduction.
Donors can contribute to the fund as often as they choose and then recommend grants to their favorite charities at a time that makes sense for them. Donations from a DAF can be made all at once or spread out over many years. Here’s how it works:
Make a Donation
You can contribute a wide range of assets to a DAF, from cash and stocks to non-traditional assets like cryptocurrencies or your stake in a business. Contributions entitle you to an income tax deduction of up to 30% of your adjusted gross income for non-cash contributions and up to 60% for cash contributions. Assets you’ve committed to a DAF cannot be withdrawn or returned to you – they exist solely for charitable grantmaking.
Grow Your Donation
Assets within a DAF are afforded special tax advantages. From the time you contribute to the fund to the time you decide to deploy your charitable gift, your contributions can be invested on a tax-free basis. The ability to grow your donations in this favorable environment may boost the impact of your giving over time. Most DAFs make a variety of investment options available to their donors.
Recommend Grants
Donors can recommend grants from their DAF to charitable organizations of their choice – assuming the organization is recognized by the IRS as a public charity. If the charity qualifies, The DAF sponsor’s directive is to make donations (called grants) on your behalf. You can have these donations occur at whatever frequency works for you. While fund sponsors are not legally obligated to abide by your grant recommendations, they generally do.
Why Might You Consider a DAF?
DAFs are attractive to some because contributions are tax deductible and can be deployed at the donor’s discretion. Indeed, Americans are making use of DAFs more now than ever to manage their tax situations and achieve flexibility with their giving.2 Here are some reasons you might consider using a DAF to facilitate your philanthropy.
Avoid Triggering Capital Gains
The sale of an investment asset that’s appreciated over time generally triggers a tax event called a capital gain. To trigger fewer capital gains, consider contributing appreciated assets to a DAF. Securities in a DAF can be sold without incurring capital gains liability.
Exit Concentrated Stock Positions
If more than 10% of your portfolio is committed to a single stock, your position is considered “concentrated.” There are plenty of reasons that you might have a concentrated position – inheritance, executive compensation, the sale of a business, etc. – but it can be a risky situation to be in. Being so heavily invested in a particular name makes you particularly vulnerable to volatility in that stock’s performance. If these stocks have appreciated, divestiture can mean incurring hefty capital gains taxes.
Instead of simply selling these appreciated assets, you can consider contributing them to a DAF.
Manage Estate Taxes
Estates that exceed a certain value may be subject to a steep estate tax. If you’re a high-net-worth individual with an inclination towards charitable giving, a DAF can help you reduce the size of your taxable estate and lower tax exposure for your beneficiaries. This is because assets you’ve contributed to a DAF aren’t subject to estate taxes and therefore don’t count toward the total value of your estate.
Are There Downsides to Using a DAF?
A DAF won’t necessarily make sense for every type of donor. There are annual expenses associated with administering the fund that donors must pay in addition to any fees on the investments they make within the fund. These costs come out of the amount that’s contributed by the donor, which may make contributions to a DAF less cost-efficient than giving directly to charity in some circumstances. Some DAFs require a minimum initial contribution to get access to the fund and a minimum grant amount for making donations. These constraints may prove cumbersome to some donors.
Interested in Exploring a DAF?
As philanthropy continues to take on a more prominent role in investors’ financial plans, both new and existing donors may be searching for ways to maximize the impact of their charitable efforts, grow their legacies, and earn some tax benefits along the way. If this describes you, a DAF is a charitable vehicle worth considering. To learn more about DAFs and how you can utilize them within your giving plan, reach out to a financial professional. There is no one size-fits-all solution to charitable giving and an advisor can help you come up with a strategy that suits you and fits within the context of your broader financial plan.
1 “Giving USA: Total U.S. Charitable Giving Remained Strong in 2021, Reaching $484.85 Billion.” Lilly Family School of Philanthropy, June 21, 2022. https://philanthropy.iupui.edu/news-events/news-item/giving-usa:–total-u.s.-charitable-giving-remained-strong-in-2021,-reaching-$484.85-billion.html?id=392.
2 “The 2022 DAF Report.” NPTrust, December 22, 2022. https://www.nptrust.org/reports/daf-report/?gclid=CjwKCAjw6dmSBhBkEiwA_W-EoDwjSl-VcVHn_Bl8uJromu1ulhHkz1hIpOoXqeJRP6WJYFhBKG-GchoCmOQQAvD_BwE.
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Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.