Generosity, or giving your money away, is perhaps one of the least discussed financial topics. Some could speculate why, but the fact remains that there are not many good strategies to help people with their philanthropic efforts. We should encourage each other to ‘pay it forward’ and give generously. In at least one small part of the government’s tax code, they agreed with me and called it the Donor Advised Fund (DAF).
What is a Donor Advised Fund?
Donor Advised Funds allow people to contribute to a specific “giving” account and claim a deduction for the contribution. In an oversimplified manner, having an account specifically designed for your charitable purposes hopefully would naturally lead you to give more away. While there are different types of DAFs, the general process is about the same.
There are three main stages to the account. First, you contribute to the DAF, whether that be cash, stock, other assets, etc. This is the moment when the tax deduction is available. The second stage is when the money is in the account. There are generally no regulations on when money must be distributed, so it is possible to leave the funds in the DAF and invest them. Finally, the last stage is to distribute the cash and donate it to charity.
Some people believe that Donor Advised Funds (and similar charitable strategies, such as private foundations) are another tactic for the rich to avoid taxes. I don’t quite understand why we should criticize these wealth vehicles. Who believes that people should not be generous and not give away money to those in need? That is the expressed purpose of a DAF, and we should incentivize everyone to give more.
Advantages
The purpose of the Donor Advised Fund is to separate the timing of the tax deduction and the actual gift to charity. Imagine a scenario where a business owner faces a major tax bill after selling their business. To help reduce her taxable income, she could contribute multiple years of “gifting” at once into the Donor Advised Fund (to take the larger tax deduction). Then she can give to the charity from that account over the next few years, instead of just writing a check.
Another advantage of a Donor Advised Fund is that it also allows you to donate appreciated assets. Any stock in a brokerage account that has doubled or tripled since you bought it may be a prime example. You can donate the appreciated stock to the Donor Advised Fund, take the tax deduction, and not have to worry anymore about the potential capital gains. Then, over time the DAF can sell and donate to your same charities, just as if you would have given to them previously. There are some limits to how much you can deduct, depending on your income, so check with your tax preparer to make sure this strategy works.
Sometimes, something as simple as having a “giving” account can be an advantage. It reminds me of the “what gets measured, gets managed” idea. Many business owners are generous people, but few have as simple and clean of a process as a Donor Advised Fund. Usually, when I bring this up, owners struggle more with who to donate to. With this account, that doesn’t have to be the constraint.
Disadvantages
The main tradeoff when using a Donor Advised Fund is the irrevocable nature of the contributions. Contributions to a DAF are irrevocable, meaning funds cannot be retrieved once added to the account. These accounts feel like you still have control over them since you can manage the investments and determine when to distribute funds to charity. But ultimately, the money is no longer yours to reallocate to other purposes if you need it.
This leads us to the second disadvantage. Technically, the manager or broker of the fund has the final say on distributions to charity. Each time you want to give money to charity, you would need the broker to approve the distribution. While the DAF has final approval over distributions, most follow the recommendations of the account holder as long as the recipient charities meet eligibility criteria. Most funds want to encourage you to deposit more money, so restricting you from donating to the charity of your choice wouldn’t be the best move. Additionally, most public charities should be available and accessible for your donations, but check with the company that runs your Donor Advised Fund to be sure.
Finally, depending on the company that runs the fund, there could be some fees and requirements as well. Some funds may require that you have a minimum balance in the account, or contribute/distribute a certain amount every so often. Like any prudent investor, make sure you understand the fees and costs associated with the Donor Advised Fund you are interested in.
Focus on Generosity
The main purpose of the Donor Advised Fund should be to help you give more. The tax deduction is nice, and I believe the IRS should continue incentivizing people to give, but it is nonetheless secondary. Having a heart for generosity and giving to charity should be much more rewarding than reducing your tax bill. The goal should be to help make your cash flow as efficient and effective as possible so more of your money goes where you want it to go.
TC Falkner 