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A donor-advised fund, or DAF, is an investment account in which all the money you contribute goes to charitable organizations. DAFs provide a way for you to donate to charities and causes that matter to you, and get an immediate tax break in the process.
More and more people interested in charitable giving are choosing to open donor-advised funds: DAFs make up about 10% of all charity donations, according to the National Philanthropic Trust. Read on to find out how DAFs work, and whether they're right for you.
How a Donor-Advised Fund Works
A donor-advised fund is like a personal investment account you set up with a specific entity, called a sponsoring organization, to give to the charities you choose. In addition to depositing money, you can contribute other types of assets to a DAF, such as stocks or real estate.
In a typical donation process, you might choose a charity you want to donate to and then send money by check or online contribution. With a DAF, you put money in an account and when you're ready, even if it's a few years later, you can choose a charity to receive the money—but you'll receive an immediate tax deduction on the amount you contribute to the fund. The process looks like this:
- You contribute a certain amount of assets to a donor-advised fund.
- You deduct the total contribution amount from your taxes that year.
- The funds can be invested and continue to grow while you decide which charities you'd like to donate to.
- You pick which charities will get the money from the fund, and the sponsoring organization makes the donation from your fund.
Accounts for donor-advised funds have to be controlled by a sponsoring organization. Sponsoring organizations must be designated as 501(c)(3) entities by the IRS, which means they are tax-exempt and can't engage in any kind of lobbying. There are a lot of institutions that fit this category, but sponsoring organizations fall into three main types:
- Community foundations
- Single-issue charities that encourage giving to a specific cause
- Commercial fund providers, also called national charities, which can be independent providers of DAFs or connected to national financial institutions like Fidelity, Vanguard or Schwab
The sponsoring organization may require a minimum investment for you to open an account. Minimum contributions for DAFs may be around $5,000, although many start at $25,000. Occasionally, there aren't any minimum investment requirements; it just depends on the sponsoring organization.
Once you open the fund, your charitable donations don't have to be in any specific amount—you simply make a recommendation to your sponsoring organization, and they distribute the funds as long as your organization of choice qualifies as a public charity with the IRS.
It's important to research potential DAFs and their sponsoring organizations carefully. Some limit the number of charities you can choose from, and most charge administrative and investment fees. The actual amount of those fees—usually charged as a flat fee or a percentage of total assets in the fund—varies by sponsoring organization.
How to Contribute to a Donor-Advised Fund
To contribute to a donor-advised fund, the first thing you'll need to do is set up an account controlled by the sponsoring organization of your choosing. To find and compare DAF sponsoring organizations, you can use Foundation Directory Online, a searchable database of grantmakers and sponsoring organizations. When comparing sponsoring organizations, consider the following questions:
- Is there a minimum contribution requirement or account balance you'll need to make and keep?
- What are the fees and payment schedules associated with the account?
- What types of investment options are there?
- What kinds of donor services and education are available?
- How closely does the sponsor stick to your donation recommendations?
- If you wind up being unhappy with the fund, do you have the ability to transfer the account to another organization?
Once you've decided on a fund and opened an account, you'll follow the sponsoring organization's specific directions for contributing. Contributions can be made in various forms, such as cash, stocks, bonds, mutual funds and even cryptocurrency. You can also contribute physical gifts, like artwork or real estate. Many sponsors can liquidate assets like this on your behalf, so the money from the transaction can be used to support the charities you choose.
Aside from more complex assets (like land), you can generally make selections of charities and give online through your sponsoring organization's web portal. Some sponsoring organizations also allow you to contribute to a general fund where your money can grow over time.
One important thing to know is that any contributions you make are nonrefundable, so there's no chance of getting your money back once you contribute.
You're allowed to claim a charitable tax deduction right when you contribute to a sponsoring organization of a DAF—you don't have to wait until the charity actually gets the money. You can usually claim a tax deduction for your donation right away, even if you don't select a charity until later.
Similar to traditional investing, different funds offer different types of investment strategies.
- Simplified investments: This is a pool of assets where you have different types of investments in one place. This is useful because when you have your money spread out among different types of investments, you reduce the risk.
- Customized investments: Some people want to have more control over their investments. Customizable investment strategies allow you to mix and match different pools and asset classes (such as index funds and active funds) to meet specific goals.
- Sustainable investments: These pools offer options that consider environmental, social and governance criteria.
If you have a financial advisor, talk to them about what investing strategy makes sense for you. If you don't have an advisor, many of these pools have professional managers who ensure the target allocations remain balanced.
What Are the Benefits of a Donor-Advised Fund?
There are a host of benefits that come with opening a donor-advised fund. They include:
- Immediate tax deductions: You can take a tax deduction even before charities receive your donation. And since the assets belong to the DAF's sponsoring organization, you won't be taxed on any growth.
- Avoiding capital gains taxes: If you donate publicly traded securities such as stocks to your DAF after holding them for one year, you will not have to pay capital gains tax on their appreciation.
- Lower costs: There are no start-up costs, whereas private foundations often include hefty legal fees. Ongoing administrative fees are also significantly lower than private foundations.
- Estate planning: DAFs can be turned into endowed funds and create a lasting legacy for years to come.
- Anonymity: Unlike foundations, grants can be made anonymously, and the names of donors are not disclosed to the public.
The Bottom Line
Donor-advised funds allow you to give back while also enjoying tax advantages. With multiple investment strategies, DAFs can be perfect for those who want to diversify their charitable giving over time.
Before donating, however, make sure you're keeping a close eye on your own financial health. Staying current on bills helps to build your credit and make it likely you'll qualify for low interest rates on loans and insurance, which could free up more cash to give to charity. Stay on top of it by monitoring your credit report and credit score, which you can do for free with Experian.