You have done well financially. You want to give some of it away. There is just one small problem:
You have no idea exactly who you want to give it to yet.
Maybe you know that education matters to you, but you have not chosen a particular scholarship program. Maybe you care about animals, medical research, your local community, or helping families in need. Or perhaps you simply know that your children do not need every last dollar of your estate.
At the same time, this happens to be a very good year for a charitable income-tax deduction.
Do you really have to choose between making a charitable gift now and figuring out your charitable priorities later?
Not necessarily.
Welcome to the world of the Donor-Advised Fund, commonly called a DAF.
A DAF can be one of the simplest and most flexible tools available for families who want to incorporate charitable giving into their financial and estate planning. It can provide some of the advantages people associate with having a private family foundation—without necessarily requiring the family to actually operate one.
But a DAF is not simply a tax-advantaged savings account. Once money goes into it, an important thing happens:
It isn’t your money anymore.
Understanding that distinction is the key to understanding both the power and the limitations of a DAF.
What Is a Donor-Advised Fund?
A donor-advised fund is a charitable giving account maintained by a sponsoring charitable organization.
Instead of creating your own private foundation, you establish a fund through a DAF sponsor. National charitable organizations, financial institutions with affiliated charitable organizations, and community foundations commonly sponsor DAF programs.
You might name yours something like:
The Smith Family Charitable Fund
or:
The Smith Family Giving Fund
You then contribute assets to the sponsoring charity and allocate those assets to your DAF account.
The contribution is generally an irrevocable charitable gift. Assuming the applicable requirements are satisfied, you may qualify for a charitable income-tax deduction in the year of the contribution.
The assets can then potentially be invested inside the DAF.
Later, you recommend grants from the fund to qualifying charitable organizations.
That creates an important separation between two decisions:
Decision #1: When should I make my charitable contribution?
and
Decision #2: Which charities should ultimately receive the money?
Those decisions do not necessarily have to happen at the same time.
That is one of the biggest attractions of a DAF.
A Simple Example
Suppose David has an unusually successful year.
He sells a business, receives a substantial bonus, exercises stock options, or recognizes a significant amount of taxable income.
David has always been charitable. He expects to give at least $20,000 per year to charity for many years.
But he does not necessarily need to make $100,000 of charitable grants this year.
David could consider contributing $100,000 to a donor-advised fund.
Subject to the applicable tax rules and limitations, he may be able to claim a charitable deduction associated with that contribution in the year he makes it.
The DAF doesn’t necessarily have to give away the entire $100,000 immediately.
David could recommend grants such as:
- $20,000 in Year 1;
- $20,000 in Year 2;
- $20,000 in Year 3;
- $20,000 in Year 4; and
- $20,000 in Year 5.
The charitable organizations receive the money over time, while David made the charitable contribution to the sponsoring organization in the earlier year.
This is sometimes referred to as “bunching” charitable contributions.
Why Would Someone Bunch Charitable Gifts?
The federal income-tax system provides a standard deduction. Taxpayers generally receive an additional federal income-tax benefit from charitable deductions only when itemizing deductions is advantageous, subject to the tax rules applicable to their particular situation.
That can create an opportunity.
Imagine a married couple regularly gives $15,000 per year to charity but otherwise has relatively limited itemized deductions.
Rather than making identical charitable contributions every calendar year, they might consider placing several years of intended charitable giving into a DAF during one year.
They potentially itemize deductions in that year and use the standard deduction in other years.
The charities can still receive grants on approximately the same schedule they otherwise would have.
The difference is the timing of the donor’s contribution.
This is why a DAF should not be viewed exclusively as a philanthropic device. It can also be a timing tool.
Appreciated Stock Can Make DAFs Even More Interesting
Cash is not necessarily the best asset to give to charity.
Suppose Susan bought stock years ago for $50,000.
Today it is worth $250,000.
If Susan sells the stock herself, she potentially realizes a $200,000 capital gain.
She could then donate cash to charity, but she has unnecessarily created a taxable event before making the charitable gift.
Instead, Susan might be able to contribute the appreciated stock directly to her donor-advised fund.
Depending upon the asset, holding period, DAF sponsor, tax rules, and Susan’s individual circumstances, this can potentially accomplish two things.
First, Susan may qualify for a charitable deduction based upon the applicable valuation rules.
Second, she generally does not personally recognize the embedded capital gain merely because she donated the appreciated asset to charity.
The sponsoring charitable organization can generally sell the contributed publicly traded securities without the capital-gains tax consequence Susan would ordinarily have incurred from selling them personally.
The proceeds can then be invested in the DAF and eventually distributed to charities.
In the right situation, that can be significantly more efficient than:
Sell stock → pay tax → donate cash.
Instead, the strategy may look more like:
Donate stock → potentially claim charitable deduction → charity sells stock → more money remains available for charitable purposes.
This is why people with highly appreciated investment portfolios should generally consider the assets they are donating—not merely the dollar amount they intend to give.
What Happens to the Money While It Is in the DAF?
DAF sponsors generally offer various investment choices.
Depending upon the sponsor, these may include conservative portfolios, bond funds, equity portfolios, index-based investments, sustainable investment options, or other investment pools.
The assets therefore do not necessarily have to sit in cash waiting for you to select a charity.
They may potentially grow.
Of course, investments can also decline in value.
And remember: you do not personally own the investment account.
The sponsoring charity owns the contributed assets. You generally have advisory privileges concerning investments and grants under the sponsor’s program.
That distinction matters.
Can I Change My Mind and Take the Money Back?
No.
This is probably the single most important fact to understand before establishing or funding a DAF.
A contribution to a DAF is generally irrevocable.
You cannot contribute $500,000, receive the charitable deduction and then decide two years later:
“I’ve reconsidered. I’d like my $500,000 back.”
It has been committed to charity.
That is the deal.
You receive significant flexibility regarding when and where charitable grants are recommended, but you give up personal ownership of the contributed assets.
Can I Give the Money to My Children?
Not through a DAF grant.
A DAF is intended for charitable giving. It generally cannot be used simply to transfer money to family members or other individuals.
Likewise, DAF rules restrict grants that provide prohibited benefits to the donor or certain related persons.
This is not the account to use to buy yourself a table at a gala, pay someone’s personal tuition bill, reimburse yourself for charitable expenses, or disguise personal spending as philanthropy.
If there is a meaningful personal benefit attached to a proposed grant, the rules need to be examined carefully.
Is a DAF the Same Thing as a Private Foundation?
No.
But for many families, it can accomplish much of what they actually wanted when they said:
“I want to start a family foundation.”
A private foundation is generally its own charitable entity. It comes with governance, tax filings, administrative responsibilities, operating rules, and expenses.
A DAF is usually much easier.
The sponsoring organization handles much of the administrative infrastructure. The donor concentrates primarily on funding the account and recommending charitable grants.
That convenience comes with a tradeoff.
With a private foundation, the family generally has substantially greater control.
With a DAF, the sponsor legally controls the assets and ultimately must approve grants.
For someone establishing a major philanthropic institution, hiring staff, running charitable programs, or pursuing sophisticated charitable objectives, a private foundation may make sense.
For someone who essentially wants to say:
“I want $2 million invested for charitable purposes, and I want my family involved in deciding which charities receive it,”
a DAF may deserve serious consideration before creating an entire private foundation.
DAFs Can Also Be Family Legacy Tools
The most interesting DAF planning may have little to do with this year’s tax return.
It can be about children and grandchildren.
Imagine parents establish the:
Johnson Family Charitable Fund.
Every Thanksgiving, the family meets.
Each child researches a charitable organization and explains why it should receive a grant.
The family discusses the organizations and decides where to recommend distributions.
Suddenly, estate planning is not simply about children waiting to inherit money.
The parents are teaching them how to give it away.
Depending upon the DAF sponsor’s rules, donors may also be able to appoint successor advisors who can continue recommending grants after the original donors die.
That allows charitable values to potentially survive for another generation without requiring the family to operate a private foundation.
Different DAF sponsors have different succession policies, however, so this should be investigated when choosing a provider rather than years later.
What About Using a DAF at Death?
DAFs can also play a role in estate planning.
A donor might establish a DAF during life and make additional charitable gifts at death.
Depending upon the overall plan, charitable gifts may be coordinated through a will, revocable trust, retirement account beneficiary designation, or other estate-planning mechanism.
This becomes particularly interesting when deciding which assets go to family and which assets go to charity.
Not every dollar in an estate has the same tax characteristics.
For example, children inheriting traditional retirement accounts may face income-tax consequences when distributions are taken.
Qualified charitable organizations generally do not face that same income-tax burden.
That means leaving a $500,000 IRA to charity and $500,000 of other assets to children can produce a different after-tax result than doing the reverse.
That does not mean everyone should name a DAF or charitable organization as an IRA beneficiary. Retirement-account beneficiary planning has technical rules, and the particular DAF sponsor must be able to accept the contemplated transfer.
But it illustrates a larger estate-planning principle:
Good charitable planning isn’t only about how much you give. It is also about what you give.
What If I Want Income From the Assets?
Then a DAF may not be the right standalone tool.
Suppose you own $2 million of highly appreciated stock.
You would like to make a substantial charitable gift, but you also want an income stream during retirement.
Once you transfer assets directly to a DAF, you cannot simply take distributions back for yourself.
That situation may call for evaluating another charitable vehicle, such as a Charitable Remainder Trust (CRT).
A CRT can potentially provide an income stream to designated noncharitable beneficiaries for a specified period, with the remaining trust assets ultimately passing to charity.
In appropriate circumstances, a DAF may even be incorporated into broader planning involving a CRT.
The point is not that one vehicle is universally better.
It is that charitable planning should start with the client’s objectives rather than with a particular product.
When Might a DAF Make Sense?
A DAF deserves consideration when someone:
- regularly makes charitable contributions;
- has an unusually high-income year;
- has appreciated securities or other appreciated assets;
- is selling a business or other valuable asset;
- wants a charitable deduction now but hasn’t selected all ultimate charities;
- wants to bunch several years of charitable giving;
- wants family members involved in philanthropy;
- wants to create a charitable legacy;
- is considering a private foundation but wants something simpler; or
- wants charitable giving integrated into a larger estate plan.
It may be particularly powerful when several of these circumstances occur simultaneously.
When Might a DAF Not Be Appropriate?
A DAF is not automatically the answer.
It may not be appropriate if you might need the contributed assets back.
It may not be appropriate if you want to retain complete legal control over the assets.
It may not provide the flexibility desired if you want to make distributions to individuals rather than qualifying charities.
And it may not be sufficient if you want to operate your own charitable programs, employ family members for legitimate foundation work, make certain specialized grants, or establish a large independent philanthropic institution.
That is when alternatives such as a private foundation, charitable trust, direct charitable giving, or a combination of strategies may become more appropriate.
DAFs Are Simple. DAF Planning Isn’t Always Simple.
Opening a donor-advised fund can be remarkably easy.
Designing the right charitable strategy can be considerably more sophisticated.
Questions can include:
What should you contribute?
When should you contribute it?
Should you give cash or appreciated investments?
How much should go into the DAF this year?
Should additional assets pass to charity at death?
Should retirement accounts be used for charitable bequests while other assets pass to family?
Should children become successor advisors?
Would a private foundation be more appropriate?
Would a charitable remainder trust accomplish an additional objective?
How does the charitable plan interact with your revocable trust, irrevocable trusts, business interests, beneficiary designations, and overall estate-tax strategy?
Those are estate-planning questions—not merely questions about opening an investment account.
You Don’t Have to Know Your Favorite Charity Yet
Perhaps the best feature of the donor-advised fund is that it recognizes something very human:
You can know that you want to give without knowing exactly where you want everything to go.
You may know that this is the right year to make a substantial charitable contribution.
You may know that your estate is larger than your family needs.
You may know that you want your children to develop a tradition of philanthropy.
You may own appreciated assets that would be particularly attractive for charitable giving.
But you may not be ready to decide whether the ultimate recipient should be a university, an animal shelter, a food bank, a hospital, an environmental organization, or a charity that does not even exist yet.
A DAF can give you time to make that decision.
You make the charitable commitment today.
You decide where the charitable dollars can do the most good tomorrow.
For the right family, that combination of tax planning, flexibility, simplicity, and legacy building can make a donor-advised fund an exceptionally useful component of a comprehensive estate plan.
This article is for general educational purposes only and is not intended as legal, tax, investment, or financial advice. Tax rules governing charitable deductions, donor-advised funds, retirement accounts, appreciated property, and estate planning are complex and subject to change. Individuals considering a donor-advised fund or other charitable-planning strategy should consult their attorney, tax advisor, and financial advisor regarding their particular circumstances.
