One of my goals after entering the decumulation phase is to give more to charity. And one of the best ways to give to charity is through a donor-advised fund. All my wealthy friends have set up donor-advised funds, so it was about time I do the same.
The following guest post about donor-advised funds is by Olaf from MileHighFinanceGuy. He will also show you how to set up a DAF through Fidelity, the brokerage firm he and I use.
The Start Of Tax-Deductible Charitable Giving
Charitable giving is a mainstay of American culture and helps advance needs not addressed through government intervention. Such acts of selflessness help improve and provide support for our local communities, marginalized groups, the environment, and society. One way to do so is through a donor-advised fund.
In 1917, wealthy people such as Rockefeller and Carnegie, were already giving away their wealth. Given the high tax rates of the era, which topped out at 67%, legislators wanted to encourage more giving. So a group of bipartisan legislators enacted legislation enshrining charitable gifts as tax-deductible against one's income.
The first donor-advised funds were created in the 1930s, though donor-advised funds were not recognized formally in the Code until the Pension Protection Act of 2006. In the 1990s, donor-advised funds began to grow in visibility and popularity, and today they are philanthropy's fastest-growing vehicles.
Over time, charitable giving has become a system of optimization. For benefactors, this means putting their funds towards endeavors that provide significant socioeconomic benefit while receiving preferential tax treatment.
Because Financial Samurai is a personal finance blog, I will not focus on how benefactors have become impact-focused. Instead, I will focus on how benefactors have learned to maximize tax benefits through donor-advised funds.
What Is A Donor-Advised Fund?
Donor-advised funds act as a medium for giving, similar to an automobile's function of providing transport.
Using them, the donor places money in a DAF, similar to how one fills up their gas tank. While the donor no longer has the money in their possession, they now have a vehicle that they can accelerate and steer towards an end goal.
For some, that goal may entail upkeeping public lands. Others may prefer to help impoverished children nearby or afar. Regardless, the donor advises the charitable foundation managing the DAF where the money should go.
Notably, the donor receives an immediate tax deduction and can spread the money amongst various charities over time, similar to a road trip.
How Donor-Advised Funds Work
Donor-advised funds (DAFs) are a simple premise:
- Donate to a charitable (holding) company¹
- Receive an income tax deduction in that tax year²
- If desired, invest the donation in various assets in the hope of further growth
- Ask the charitable company operating the DAF to disperse the funds to a final recipient(s)³
There is (generally) no minimum or maximum donation amount, nor is there a timeframe for fund dispersion.
- The holding company must be a 501(c)(3) charity, such as Fidelity or Vanguard Charitable. Both charities are distinct legal entities separate from their respective brokerage partner. However, each has contractual agreements with their brokerage counterpart to receive administrative help, permission to use intellectual property, and investment assistance.
- Donors can deduct up to 60% of their adjusted gross income. Still, feel free to donate above this amount!
- The final recipient of DAF monies must be a 501(c)(3) charity, such as the American Red Cross and the World Wildlife Fund.
Why Use A DAF? Double Tax Benefit
DAFs are often deployed by donating highly-appreciated securities in-kind, which optimizes tax savings since capital taxes are avoided and income taxes are lower.
In laypersons terms, DAFs are best used to donate securities that will incur more significant tax burdens. By doing so, the donor can deduct the amount without realizing capital gains and concurrently lower their income tax burden. Talk about a double tax advantage!
Donors can contribute directly from brokerage accounts. Unfortunately, IRAs cannot contribute to DAFs directly and can only be set as a beneficiary. Still, IRA donations to a charity that is not a DAF can be used to satisfy yearly RMD requirements for those 72 and older without incurring income taxes on withdrawals (401(k) ‘s don't have this feature).
DAF operators such as Fidelity and Vanguard Charitable enable the donor to give securities and assets in-kind. These include including public stocks, bitcoin, artwork, private business ownership, and more. Before using a specific DAF operator, ensure they can process the securities or assets you wish to gift.
An Example Of A Donor Advised Fund
In the example above, you will see I had a lot of 162 shares of the Vanguard S&P 500 ETF (VOO) purchased on 3/23/2020. The shares had appreciated substantially. I could have received a deduction of $66,408.66* against my income taxes without incurring capital gain taxes on the appreciated sum of $32,613.84. Thus, I would have saved capital gains taxes equal to $4,892.08 since I am in the 15% long-term capital gains tax bracket.
*Assuming that $66,408.66 does not exceed 60% of my AGI
Dispersing & Investing Donor-Advised Funds
Once your donation is complete and your account is funded, you can recommend a grant. I say recommend because technically, you aren't directing donations after the initial contribution is made. The DAF Sponsor is responsible for the funds after your donation and makes all decisions subsequently. However, when you recommend grants, they choose whether to approve them or not.
While technically, the Sponsor could deny your recommendation, the chances remain unlikely this would occur. If it did, the Sponsor would lose future benefactors that would instead go to a more honorable DAF. Similarly, when it comes to investment choices, your selections are recommendations, too.
Thus, a level of trust is required. Fidelity Charitable has publicly stated they do not interfere with the grant-making process, nor does Vanguard. If you can accept these terms, you are nearly ready to complete a donation. But first we must discuss fees and minimums!
Minimum Amount Recommended To Open A Donor-Advised Fund
There is no minimum donation with Fidelity Charitable. However, it only makes sense to open a donor-advised fund if you plan to give a sum that exceeds ~$10,000 during that year. Why? Because of taxes, fees, and minimums.
Under the current tax code, every filer(s) qualifies for a standard deduction of up to $12,950 annually. Therefore, many taxpayers do not itemize their deductions anymore.
Because of the standard deduction, utilizing a DAF is likely not worthwhile unless you plan to invest the money in it or if your itemized deductions exceed $13,000 annually. (Common itemized deductions include qualified charitable donations and mortgage interest expenses, the latter of which may be subject to limitations.)
The Fee And Cost For Having A Donor-Advised Fund
To open and operate a donor-advised fund at Fidelity will cost 0.60% of assets or $100, whichever is greater. At Vanguard Charitable, the minimum charitable pledge is $25,000, and administrative fees start at 0.60%.
Fidelity and Vanguard Charitable lower their administrative costs as the donated sums/balances increase. They draw 1/365 of their 0.60% fee for daily collections. At year-end, Fidelity Charitable assesses a $100 prorated fee for the days used if billing was sub-$100.
While administrative fees may seem peculiar for a DAF, Fidelity and Vanguard Charitable are non-profit intermediaries. They must sustain their organizations to continue day-to-day operations. One such activity is exchanging donations from various asset types into cash. This is notable since most charities will not accept securities, bitcoin, or other in-kind assets.
Invest Your Donation Before Dispersement
If you recommend investing your donation before dispersing the funds to a selected charity, the investment will have an expense ratio (i.e., a hidden fee that you cannot see).
Fidelity offers indexed and active fund choices, while Vanguard offers indexed ones. While these investments provide the opportunity for growth, they can lose money. If you don't plan to invest the donation before dispersing the funds to an end charity, select the money market option (which has an expense ratio, too).
One way to offset these fees is by rounding up your donation to neutralize any fees paid so that your end charities get the intended amount. On both Fidelity and Vanguard's sites, you can read how and when these fees are deducted.
If DAF Sponsors can help you time a tax benefit to receive a valuable deduction while helping others, the fees are worthwhile. Still, this is a decision that only you can make.
As an aside, Fidelity Charitable has created over $21 billion in excess grant dollars through investing donations. Vanguard does not release figures on donation growth.
How To Open A Donor-Advised Fund With Fidelity Charitable
Step 1: To open a Giving Account with Fidelity Charitable, you must provide your name, address, and other information regularly used when opening a bank account. Additionally, you should select a successor who would take control if you die before the funds are fully dispersed.
Step 2: Next, you will fund your Giving Account by donating cash, securities, or other assets. Certain asset classes require you to work with a representative to assist with donations (such as artwork or private business ownership). I will show you how to donate existing appreciated equities. Select “Maximize the tax advantages of your donation” and choose an account and an approximate dollar amount you want to donate.
Step 3: Choose the number of shares you wish to donate from your different lots (i.e., prior purchases). During this step, you can see how much your different securities have appreciated and their original cost basis.
Step 4: Choose an investment strategy for your donated securities. Once given, the DAF will sell your assets and convert them to this investment strategy.
Because the Fidelity and Vanguard brokerages run these funds, they will make money off the expense ratio of the chosen fund. Choose wisely, as these funds can lose money during market downturns if invested in stocks or bonds.
I plan to donate these proceeds immediately, so investing these into the stock market would be reckless. I selected the conservative income fund, but you can choose a money market fund under “Create a customized investment strategy.”
Step 5: Confirm the details are correct and submit.
You will receive a confirmation when complete; the process usually takes 3 to 6 business days.
Step 6: Once your donation is processed, and your Giving Account is funded, you can recommend a grant. This waiting period took 3 business days for my gift.
The next step is finding a charity or charities to which you want to send funds.
Select “Find a charity” and enter the charity's tax ID number or search for it by name.
Step 7: Once you select a charity, you can name the intended use for the donation. The default option is “Where it's most needed.” If you designate a specific use or cause, it can slow down the donation process. I chose the no-kill shelter from which I adopted my tabby cat and left a thank you message in the use box.
For the timing section, you can donate now, in the future, or make your donation recurring. I decided to donate now/ASAP.
Once you have settled on these details, add the transaction to your charity list using the “Add to list” button seen in the previous image. After selecting the “Add to list” button, it will transition to say “Added.” Your donation will then appear on the “Grant list” section on the right.
You can now click the “Next step” button.
Step 8: You will now select where your recommended grant funds from in your Giving Account. Choose whichever holdings you wish to sell and move on to the next step once set.
Step 9: A summary screen will now list the grant details so you can confirm everything is accurate. Once you have reviewed the details, you must agree that the selected charity provides you with no impermissible benefits for your generosity.
Step 10: Woo-hoo! You have now recommended a grant using your Giving Account.
Now, you wait, log in, and view the “Recent grant activity” screen on the landing screen to see the status of your grant. Eventually, it will switch from final processing to check mailed to check deposited.
Step 11: When you file your taxes the following year, visit the History section to access your statements to download tax receipts, annual donation amounts, and IRS Form 8283.
A Donor-Advised Fund Is A Tax-Efficient Way To Give
Congratulations! You now know how donor-advised funds work and how to contribute to them while maximizing the tax benefits for the impact you want to make! The world is in need, so where will you donate? Have a great day!
Author bio: Olaf lives in Colorado and runs the blog MileHighFinanceGuy.com, where he shares personal finance knowledge with others. Previously, he specialized in retirement planning at the US's largest 401(k) provider. Olaf now works two part-time jobs as a financial advisor and winery consultant. He enjoys his financially independent life with his fiancée exploring other cultures and the great outdoors.