Is a Donor-Advised Fund Right for You?

Looking for tax-efficient ways to generate and preserve wealth is one of our key jobs as wealth managers. Many of our clients believe it’s important to support the organizations and causes they care about, and we are here to help them do so in a wealth-generating way.

One way to combine tax efficiency with charitable giving is to contribute to a donor-advised fund. Many custodians offer these vehicles, including Schwab’s DAFgiving360 (formerly Schwab Charitable) and Fidelity Charitable, which we mention below in our examples. This post explains why a charitable contribution made through a donor-advised fund is a powerful strategy and how to tell if it is a good fit for you.

What Is a Donor-Advised Fund?

A donor-advised fund (DAF) is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization under the Internal Revenue Code. Individuals can contribute cash or securities to the DAF and donate the assets to a charity, either sooner or later.

Contributing to a donor-advised fund allows you to take a current-year tax deduction, if you are eligible to itemize. Those who are not eligible to itemize deductions can make a large lump sum contribution to pre-fund several years of charitable donations at once, to overcome the standard deduction threshold.

After contributing to the fund, you will make individual gifts to charities (called “grants”) via your DAF custodian. Once the custodian approves it, a grant letter and check will be sent to each charity.

Your grant can be made anonymously, if you desire.

Who Should Contribute to a Donor-Advised Fund?

Some may believe that a donor-advised fund only makes sense for very wealthy people, or those who have surpassed a certain asset level. But that’s simply not the case. For example, there is no minimum contribution requirement to open either a Schwab DAFgiving360 or a Fidelity Charitable account, and account holders can grant as little as $50 per charity. A donor-advised fund may make sense for anyone who wants to contribute to charity in a tax-efficient way, particularly those in a high tax bracket or who have highly appreciated stock, meaning stock with a low cost basis and large unrealized gain.

Note that giving stock or funds with embedded gains to charity reduces your taxes only if you’ve owned the stock for more than a year. If you have not held the stock for more than a year, the charitable deduction is limited to your cost basis (the amount you paid) rather than the fair market value.

Benefits of Making Charitable Gifts Using a Donor-Advised Fund

With a donor-advised fund, you may be able to give more to charity than you would if you were donating cash, thanks to the tax savings involved.

Let’s look at an example: Imagine you hold stock purchased decades ago for $10,000. The value has grown substantially, and your stock is now worth $200,000. Thus, you have a large, unrealized capital gain of $190,000.

One way to donate to charity using those shares is to sell them, pay tax on the gain, and donate the net proceeds to a specific organization.

With a donor-advised fund, however, you can accomplish your philanthropic goals by contributing the shares in-kind, without selling them, and avoid a realized gain and a corresponding tax liability. Plus, you’ll receive a tax deduction for $200,000, the full fair market value of the shares.

This is why contributing to a donor-advised fund is a highly tax-efficient charitable strategy.

Part of the beauty of charitable planning using a DAF is to keep your taxes low, especially if you expect your earnings to change over time. In your peak earning years, use a DAF to lower your taxable income as you head into retirement, specifically in years your tax bracket is high, by pre-funding several years’ worth of contributions to provide a large tax deduction and get the most bang for your buck. Then, when your tax bracket is lower (and any charitable deduction will be lower), you can make grants to charities from the stockpiled contributions in your DAF. The funds can sit in your account and even be invested for growth, if you have a medium-to-long time horizon before making grants.

Drawbacks of a Donor-Advised Fund

As donor-advised funds are operated by a sponsoring organization, administrative fees are typically associated with maintaining them. Schwab DAFgiving360, for example, charges an annualized administrative fee ranging from 0.10% to 0.60%, depending on the average daily value of assets in the account. Fidelity Charitable’s investment fees range from 0.015% to 0.91%, based on the underlying funds of the investment pools.

Additionally, if you choose to invest the funds in your account, rather than leaving them in cash, the underlying mutual funds have their own associated fees. Contributing an amount that will satisfy multiple years of charitable grants is best done when you’re in a high tax bracket just before retirement, but not earlier, to minimize your fees.

Keep in mind that once you contribute to a donor-advised fund, the assets are legally owned by the sponsoring organization, which has no obligation to adhere to your granting wishes. However, it’s very uncommon for a grant request to be rejected.

Where to Open a Donor-Advised Fund

Many financial institutions offer donor-advised funds, including Schwab, Fidelity, and Vanguard. Our clients prefer either Schwab or Fidelity, due to the highly-responsive service team, efficiency of contributing assets from an existing brokerage account, and the convenience of consolidating accounts in one place. There is no obligation for our clients to use any particular custodian; we do not receive financial compensation from Schwab DAFgiving360 or Fidelity Charitable.

If you have questions about donor-advised funds or would like to learn more about our financial planning services, please reach out to us.

About the Author

Joyce L. Franklin, CPA, CFP®, is a Partner and Senior Wealth Advisor at Mission Wealth. She advises employees and executives in tech and human resources on wealth management, tax, and financial planning. She designs, implements, and monitors financial plans, coordinating each client’s goals, values, and risk tolerance.