What is a Donor Advised Fund?

Donor advised funds are charitable investment accounts that allow you to make contributions to qualified charities while your money grows tax free.

Many clients choose this type of charitable vehicle if they have substantial unrealized long term capital gains (for example, if you have highly appreciated stock or a business you are considering selling), but want to avoid income tax (realized gain) when the asset is sold.

Since such assets would be sold through the donor advised fund, you would pay no income tax on the appreciation and you get a charitable deduction for the value of the contribution. This could be a huge win-win if you already have a giving plan in place, because instead of using after tax dollars, you could effectively fund future donations with pre-tax dollars.

In other words, rather than using after-tax wages, interests, dividends, or rental income to make charitable donations, you could place your appreciated stock in the donor advised fund and use that value for future donations for years to come and never see a tax bill (but get a tax deduction instead).

Many custodians have their own version of donor advised funds (for example, Fidelity’s is called “Giving Accounts”), which allow you to easily set up and fund the account (they do virtually all the work for you).

Why would I choose to use a donor advised fund instead of a private foundation, charitable trust, or giving outright to charity?

Donors advised funds are a convenient way for you to get some of the benefits of a charitable trust or private foundation with virtually none of the work.

While specific requirements differ, both charitable trusts and private foundations require a higher administrative burden and additional paperwork to complete to make sure you don’t get in trouble with the IRS.

For example, you would generally have to hire an attorney to draft documents to meet the appropriate legal requirement while satisfying your intentions (which means you would have to actually read super fun legal documents), then you would have to complete (or hire someone to complete) and file form 990 or 990-PF as well as annual 1041’s if you have taxable income in any given year. 

Some people may argue that donor advised funds are cheaper because they don’t require an attorney or CPA to make sure everything is structured properly and in compliance with IRS rules, however, most donor advised funds have an asset under management fee (for example, 1%) that can add up over time. So, when it comes to cost, you would have to compare the hourly rate fee of your CPA / attorney vs. the AUM percent fee of the amount you plan to contribute for charitable purposes.

Nonetheless, many people who plan to contribute less than $1,000,000, find donors advised funds to be the better choice, all other things being equal, and if you're just focused on cost control. 

What are the advantages of Donor advised funds?

The advantages of Donor Advised Funds are:

1. Easy to set up and relatively easier to fund than private foundation / charitable trust

2. Can get immediate income tax deduction

3. No capital gains tax on appreciated stock/business

4. Simple to use donation and grant writing process

   1. You pick the public charities, how much to give, and may be able to add restrictions / parameters on the donation

5. Investments in the account will continue to grow tax free until they are donated to the charity of your choosing

6. You can name a successor manager of your donor advised fund account in case something happens to you (easy transition for estate planning purposes)

7. No CPA or attorney required (although might still be helpful in certain situations)

What are the disadvantages of donor advised funds?

The disadvantages of donor advised funds are:

1. Limited to public charities 

2. Not as flexible or customizable as private foundation / charitable trust 

3. Works best for what would otherwise be large taxable events (sale of highly appreciated stock or business) 

4. Unlike charitable trusts, there is no split interest beneficiary - meaning it all has to go to charities, whereas with a charitable trust, you could have non-charitable beneficiaries (you, your spouse, or your children, for example)

5. There is an asset under management fee, so if you are contributing a substantial amount then you may want to do a net present value calculation on the 1% fee (or whatever it may be) in absolute dollars to determine whether it is really the most cost effective solution for you. Once again, unless you have millions to donate, donor advised funds are usually the more cost effective option for most people.

Why not just make a gift outright to charity rather than using a donor advised fund?

Honestly, for many people, an outright gift could be a great idea. In fact, many people do this type of thing with qualified charitable distributions directly from their traditional IRAs. 

There are two primary reasons a person may prefer to do a donor advised fund vs. gifting it all outright to charity.

1. They don’t want to give up complete control just yet - instead they prefer to send gifts over time (and let investments grow tax free in the meantime).

   • This is especially the case when a person already has an annual giving plan and has just decided to front load a donor advised fund for income tax planning purposes.
     

2. They want an easy way to spread out the money - donor advised funds give you a convenient way to split your contributions among thousands of qualified charities.

   • Whereas if you had to manually gift your appreciated stock to the same number of charities, it could be an administrative nightmare.

If you’re curious how a donor advised fund may fit into your overall estate plan, then give me a call at 781 202 6368, email me at jlento@perennialtrust.com, or click here to schedule your free personal consultation.

I’m always happy to help,

Joseph M. Lento, J.D.

Your Local Estate Planning Attorney

www.PerennialEstatePlanning.com

477 Main Street

Stoneham, MA 02180