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Pros and Cons of Donor-Advised Funds

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Donor-advised funds (DAFs) offer a streamlined way to give to charity, combining tax advantages with flexibility. One major benefit is the immediate tax deduction you receive upon donating to a DAF, even if the funds are distributed to charities over time. However, administrative fees can eat in to the value of your donation, and while the initial tax benefit is immediate, the funds might remain in the DAF for years before reaching the intended charities, delaying their impact. Despite these limitations, DAFs can help those who want to maximize their philanthropic impact and get tax benefits.

If you need guidance when it comes to charitable giving, consider working with a financial advisor. Connect with a fiduciary advisor today.

What Is a Donor-Advised Fund? 

A donor-advised fund (DAF) allows individuals to donate assets to a fund managed by a sponsoring organization, which can be a public charity, community foundation or financial services company. These are responsible for maintaining the fund, complying with regulations and executing the donor’s recommendations regarding grants.

Donors make irrevocable contributions to the fund and receive an immediate tax deduction, while maintaining some advisory privileges over the distribution of funds and investment options.

Here’s how it works: Once a donor contributes to the fund, the assets are invested according to the donor’s preferences, and any growth in the fund is tax-free. Donors can then recommend grants to qualified charities over time, allowing for strategic philanthropic planning.

The Rise of Donor-Advised Funds

A financial advisor meets with a pair of wealthy clients to discuss their desire to contribute to a donor-advised fund.

Initially, these funds were managed by community foundations, but today, many financial institutions and public charities also offer them. DAFs have become an increasingly common vehicle for philanthropic giving, particularly among affluent donors seeking a more strategic approach to their charitable contributions.

In 2018, there were approximately 861,000 DAF accounts. That number more than doubled to 1.94 million by 2022, according to the National Philanthropic Trust, which also found that total DAF assets rose from $123 billion to $228 billion during that time. 

This increase reflects a broader trend of strategic philanthropy, where donors wish to make a lasting impact with their contributions. The flexibility and tax benefits of DAFs make them an attractive option for those who want to donate appreciated assets, avoid capital gains taxes, and receive an immediate tax deduction.

Pros of Donor-Advised Funds

1. Tax Benefits

One of the primary advantages of contributing to a DAF is the immediate tax deduction received for donations, which can be claimed in the year the contribution is made. This allows donors to reduce their taxable income, potentially lowering their overall tax liability. 

For cash contributions, the deduction can be up to 60% of adjusted gross income (AGI). And for appreciated securities or other assets, the deduction is capped at 30% of AGI. It’s important to itemize deductions on your tax return to claim these benefits.

Additionally, DAFs also allow donors to avoid capital gains taxes on appreciated assets, making them particularly advantageous for those with highly appreciated investments. The fair market value of the asset at the time of donation is deductible, which can significantly enhance the tax benefit.

DAFs also provide flexibility in timing charitable grants. Donors can take immediate tax deductions while having the flexibility to distribute grants to their chosen charities over an extended period. This feature is particularly beneficial for those who wish to make a substantial charitable impact but prefer to strategize their giving over several years.

2. Investment Growth

Another benefit of DAFs is the ability to grow investments tax-free. Once the donation is made, the funds are invested according to the donor’s preferences, with any earnings from these investments being tax-free. This growth can significantly increase the amount available for charitable grants over time, amplifying the impact of the initial contribution. The ability to invest in a range of asset classes, such as stocks, bonds and mutual funds, offers donors the opportunity to potentially enhance their charitable giving.

3. Charitable Flexibility

By allowing donors to make a philanthropic contribution with recommendations of how the money should be invested and disbursed, DAFs provide a structured yet adaptable way to support multiple causes. Donors can take their time to decide which organizations to support, adjust their giving in response to changing circumstances, and even involve their families in philanthropic decisions.

4. Optional Privacy

DAFs allow donors to make charitable contributions without publicly disclosing their identity. This privacy feature protects them from unwanted solicitations and provides confidentiality in their philanthropic activities.

Cons of Donor-Advised Funds

1. Loss of Control

When you contribute to a DAF, you effectively relinquish direct control over your donated assets. While you can recommend grants to specific charities, the final decision rests with the DAF sponsor. This structure means that, unlike direct donations where you have complete discretion over how and when funds are used, the DAF sponsor has the ultimate authority to approve or deny your recommendations. This loss of control can be a significant disadvantage for donors who prefer to have a hands-on approach to their charitable giving, ensuring their contributions align precisely with their philanthropic goals.

2. Costs and Fees

Administrative fees are charged to cover the operational expenses of managing the fund, which can vary depending on the sponsoring organization. Additionally, there are investment management fees that apply to the assets within the DAF, often a percentage of the invested amount. These costs can erode the overall value of the donations, making it essential for donors to carefully consider the fee structure when choosing a DAF.

3. Delayed Impact 

Contributions to a DAF are not required to be disbursed to charities immediately. Instead, the funds can sit in the account indefinitely. This means that while the donor may receive an immediate tax benefit, the charitable organizations intended to benefit may experience delays in receiving the financial support they need. This lag can be particularly problematic during times of urgent need, where immediate funding is crucial for relief efforts or ongoing projects.

4. No Payout Requirements

Unlike private foundations that must distribute a certain percentage of their assets annually, DAFs face no such obligation. This means that funds can remain in these accounts indefinitely, potentially delaying much-needed charitable contributions. While this can allow donors to plan their giving strategically, it also raises concerns about funds not reaching the intended beneficiaries in a timely manner.

Should You Contribute to a Donor-Advised Fund?

A wealthy couple meets with their financial advisor to finalize their contributions to a donor-advised fund.

A DAF allows you to make a charitable contribution, receive an immediate tax deduction and then recommend grants from the fund over time. This flexibility can be advantageous if you want to separate the timing of your donation from your charitable grants. Additionally, the fund’s investment growth can potentially increase the amount available for future donations.

However, you must also consider your financial situation and charitable goals. If you prefer more control over your donations or wish to support smaller, less-established charities, a DAF may not be the best fit. Fees and minimum contributions can also vary, impacting your decision.

Bottom Line

DAFs are charitable giving vehicles that allow individuals to make irrevocable contributions and then recommend grants to charitable organizations over time. The main benefits include tax deductions, flexibility in giving and the ability to grow contributions tax-free. However, there are drawbacks: once a donation is made, it cannot be retracted and administrative fees can reduce the amount available for grants. Additionally, donors may have limited control over the fund’s investments. Overall, DAFs provide a structured approach to philanthropy, blending immediate tax advantages with long-term charitable impact.

Tips for Charitable Giving

  • If contributing to a donor-advised fund isn’t quite for you, there are other tax-advantaged ways to donate to charity. For example, retirees with traditional IRAs can donate a portion of their retirement savings to qualified charities using what’s called a qualified charitable distribution (QCD). These donations, which come out of an IRA, count toward a donor’s required minimum distributions (RMDs) for the year but do not add to their taxable income.
  • If you need help managing your money and planning your charitable contributions, consider connecting with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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