Donor-advised funds (DAFs) allow a person, family, or organization to place assets into a private fund that is administered and managed by a third party for the purpose of making charitable donations. The donor or donors maintain the authority to direct the timing and placement of distributions from the fund. This blog, the fourth in a series about charitable gift planning, will discuss the structure and benefits of DAFs and how these funds can be a part of your overall estate and wealth planning in West Virginia (WV), Kentucky (KY), Ohio (OH), and elsewhere.
Understanding the Limitations and Benefits of DAFs
Donor-advised funds have gained popularity as a wealth planning and charitable giving tool in recent years. In 2019, assets equaling more than $121 billion were held in DAF accounts. Contributions to DAFs increased by 20 percent and grants distributed from DAF accounts increased by 19 percent, totaling more than 23 billion, according to the National Philanthropic Trust.
There are several reasons donor-advised funds have become a popular tool for charitable giving. They are relatively easy to open if you have the cash or assets to contribute. Many DAF accounts can even be created online with relative ease.
However, to maximize the benefits of DAFs or charitable giving of any substantial kind, the financial and legal vehicles used to protect and distribute funds should be part of your overall estate and wealth planning, ideally under the guidance of knowledgeable counsel for planned giving.
The Pros and Cons of Donor-Advised Funds
Before committing your cash or other assets to any financial vehicle, careful consideration of the advantages and disadvantages is key. So what are the pros and cons of donor-advised funds?
DAFs are administered and managed by an IRS-qualified sponsoring organization, or sponsor. These organizations are registered 501(c)(3), tax-exempt entities. The sponsor holds the funds and disburses them to charitable organizations as directed by the account holder or holders. This creates a simpler, more efficient form of giving than some of the other available tools while retaining a level of control and tax benefits for the donor.
It is imperative to understand that assets placed in a donor-advised fund should be entirely intended for charitable purposes. The tax advantages and other benefits of DAFs are substantial, but the donations placed in these accounts are irrevocable and must be distributed to qualified charities. The donor cannot recover these assets for personal use at a later time. And, while the donor is granted the authority to designate how and when distributions are made, the sponsoring organization is the legal owner of the assets in a donor-advised fund.
Since the assets placed in a DAF are designated for charitable purposes and irretrievable by the donor, the value of those assets is considered an immediate charitable gift for tax purposes, even if distributions from the account have not yet been made. Unlike some charitable giving vehicles, like private foundations, there is no requirement to make distributions from a DAF within specific timeframes or in certain amounts. One of the benefits of DAFs is that this allows donors who would like to receive the tax benefits of a charitable gift deduction to realize those advantages in the short term, even if they are undecided about where they would like their financial support to go with regard to the specific charity or cause.
DAFs can be funded with cash, securities, and other assets, like real estate. Appreciated assets can be a good fit for inclusion in a DAF: the donor of the asset receives a charitable tax deduction for the fair market value of the assets and capital gains taxes are not incurred when the assets are sold because the seller is a tax-exempt entity. This makes DAFs a good vehicle for converting assets to cash to be used for charitable purposes.
While a donor-advised fund can increase the amount ultimately donated to charity, sponsoring organizations also charge fees for their services, so weighing the pros and cons of donor-advised funds must involve careful consideration of these factors.
In summary, the benefits of DAFs include the following, which should be weighed against the disadvantages and concerns noted above and considered within the broader scope of your charitable giving and wealth planning:
- Charitable income tax deductions;
- Elimination of capital gains tax on the growth and sale of assets;
- Reduction of estate taxes by decreasing the value of the estate;
- Control over timing and placement of charitable gifts;
- Ability of funds to receive contributions from multiple donors;
- Simplified, more efficient administration of funds and conversion of assets for the donor and charities; and
- Increased funds available for charitable causes as a result of tax exemption.
What You Need to Know about DAF Sponsors
Several types of organizations hold and manage donor-advised funds on behalf of donors. For donors with an interest in giving back within a specific geographical area, community foundations are an option. These groups generally employ a small staff who are knowledgeable about local charitable organizations and can make recommendations based on the donor’s preferences. Community foundations typically also offer additional charitable support to the communities they serve in the form of grants and other initiatives. The Foundation for the Tri-State Community and The Greater Kanawha Valley Foundation are two such organizations serving the tristate area of WV, KY, and OH.
If you are interested in supporting a specific cause, some foundations that sponsor DAFs focus their efforts in a targeted area of charitable work. While these can include local entities with a more precise focus than community foundations, many of these organizations support a specific interest nationally or internationally. Like community foundations, donor-advised funds are often one offering available to donors in supporting the greater missions of these foundations.
Other national organizations that administer DAFs include noncommercial foundations and trusts that exist for the primary or sole purpose of administering donor-advised funds, like the National Philanthropic Trust. Finally, some commercial financial services companies have charitable arms that offer donor-advised funds. DAFs administered by these providers are often more flexible and offer the broadest scope of charitable causes a donor can potentially support.
How to Open a Donor-Advised Fund
If a DAF sounds like it might be a good fit for your estate and wealth planning strategy, you’ll be interested in learning how to open a donor-advised fund. Technically, the process of opening a DAF is relatively simple. As mentioned previously, some sponsors even allow you to create your account online.
Before you take that step, however, engage in some soul-searching and vetting. Donors must identify the type of organization they want to work with in administering the donor-advised fund. This involves deciding if you wish to support a particular community or cause or if you would prefer to have a broader range of options for granting distributions.
Once you have decided which type of sponsoring organization is the best fit, it is critical to thoroughly evaluate the groups you are considering. The IRS has stated that it is aware of organizations that abuse the tax privileges granted to 501(c)(3) groups and this can result in repercussions for these groups as well as the donors who work with them.
In addition to outright fraud, donors should be aware of the possibility of basic mismanagement or incompetence on the part of an organization that administers DAFs. If the group that manages your account fails to remain viable, your investment could ultimately be lost and not serve the charitable purpose you intended.
Counsel for Planned Giving Can Help You Maximize the Benefits of DAFS
Consulting with an experienced estate and wealth planning attorney is the best way to ensure that your charitable giving plan, whether it involves a donor-advised fund or not, complements and enhances your overall financial and charitable goals and interests, both during your life and after. Anna M. Price of Jenkins Fenstermaker, PLLC provides counsel for planned giving to clients in WV, KY, and OH. Contact Anna to discuss the benefits of DAFs or other aspects of charitable giving by calling (304) 523-2100 or completing the firm’s online contact form.
Disclaimer: The references here to specific DAF sponsoring organizations do not constitute endorsements.