January 26, 2023
Donor-Advised Funds Can Enhance Charitable Giving
Donor-advised funds (DAFs) are perhaps the fastest growing charitable giving vehicle in the United States. A DAF is similar to a charitable investment account for the sole purpose of supporting charitable organizations. DAFs are easy to establish and generally provide an immediate income tax deduction (subject to limitations). The funds can be invested for tax-free growth and doled out for benefit of one or more charities in a lump sum or in smaller amounts over many years.
We now answer the following three questions:
- What are the DAF fundamentals?
- What assets can be put into a DAF?
- What vehicles can be deployed to facilitate funding?
What are the DAF fundamentals?
Donor-advised funds are easy to set up and require little ongoing maintenance on the part of the donor. An irrevocable gift is made to a fund sponsor, generating a current year charitable deduction. Although there is no limit on how much can be contributed into a DAF, there are limitations on how much a taxpayer may deduct in a given year in connection with charitable contributions.
Once funded, the donor can recommend grants out of the DAF to charitable organizations, subject to any restrictions the fund sponsor may impose. Typically, any IRS-designated 501(c)(3) public charity will qualify. Should a donor have specific charitable organizations in mind, the donor should ensure that the sponsor would look favorably on grant requests to such organizations before selecting that sponsor, as the sponsor has the final say.
Some fund sponsors allow the donor to select the investment manager; others have their own manager(s) that are required to be used.
Private foundations and donor-advised funds are charitable giving vehicles that help donors facilitate their giving and achieve their philanthropic goals. Though there are several similarities between the two vehicles, two important distinctions are:
- The donor of a DAF can make recommendations to the fund sponsor as to a proposed distribution but does not have legal control (thus the name, donor-advised).
- Some DAFs only allow grants to IRS-qualified, 501(c)(3) public charities.
In contrast, private foundations tend to have a wider range of possible recipients, but are subject to more stringent tax laws, tax reporting, record keeping, minimum annual distributions and other fiduciary oversight requirements. Some DAF sponsors will allow grants to organizations that are not recognized by the IRS as public charities if the grant is for purely charitable purposes. There is typically an added cost associated with such grants.
What assets can be contributed into a DAF?
Although cash can be contributed, giving non-cash assets is often more tax advantageous. Typically, it is more tax efficient to donate appreciated assets than to sell them, incur capital gains, and contribute the cash proceeds.
So, what other types of assets can be used? Depending on the sponsor, one or more of the following may be eligible:
- Bitcoin and other cryptocurrencies
- Cash and cash equivalents
- Interests in privately held entities, such as LLC membership interests, partnership interests and shares of a C-corp and S-corp
- IRAs and other qualified retirement plans
- Life insurance
- Private equity and hedge fund interests
- Publicly traded securities or mutual fund shares
- Real estate
- Restricted stock
- Tangible property, such as art and jewelry
What Methods can be used to contribute to a DAF?
We previously recognized that direct gifts of cash are possible, and further, that gifts of certain assets in-kind could be more tax efficient. But there is another consideration beyond the asset type used to fund a DAF: The way in which the asset is transferred into the DAF.
A frequent form of giving is a direct transfer, such as of cash or appreciated stock, into the DAF account. This is effective and straightforward.
You can name the DAF as a beneficiary of life insurance or retirement accounts.
- There are limitations on transfers from IRAs and other retirement accounts to DAFs during the owner’s lifetime, but retirement accounts can be transferred at death by beneficiary designation. A DAF may be designated as the beneficiary of a specific sum, percentage, or the entire account.
- Individuals ages 70 ½ or older can use their IRAs to make qualified charitable distributions (QCDs). If paid directly to a qualified charity (accomplished by having the distribution check made payable to it), an IRA owner does not have to pay tax on up to $100,000 of QCDs per year. These can be made with voluntary withdrawals as well as with required minimum distributions. However, QCDs can go only to qualified charities and not to DAFs, supporting organizations or private foundations.
- Under the recently passed SECURE Act 2.0, as we have previously advised, up to $50,000 of a QCD may be distributed into a charitable remainder trust or charitable gift annuity.
Change of Ownership
Title or ownership of assets can be put in the name of the DAF. This could include life insurance (or one can retain ownership and name the DAF as the beneficiary), titled property such as a car, or untitled property such as art or jewelry.
This is a contribution that is triggered in the future, typically at death through an estate plan (e.g., a specific gift in a Will or Revocable Trust).
Split Interest Trusts
A split interest trust is one that splits benefits between charitable and non-charitable beneficiaries. There are two major forms of split interest trusts, and two variations of each.
Charitable Remainder Trusts
These trusts are established during lifetime or at death, with a lead payout to one or more persons (can include the donor) for a period of years or lifetime, and after the lead interest, the remainder goes to a charity, such as a DAF.
Charitable Lead Trusts
The inverse of the remainder trust, the lead interest is payable to the charity (e.g., a DAF), and the remainder often to children or grandchildren.
The two variations of split interest trusts are annuity trusts and unitrusts. This determines the value of the lead interest.
- Under an annuity trust, the percentage payout is on the initial funding value.
- Under a unitrust, the percentage payout is on the annual value of the assets.
The Internal Revenue Code provides that gifts to qualified charities are tax deductible, but the ability to take advantage of a deduction on a Form 1040 income tax return is not unlimited. In fact, the deduction is subject to strict limitations based on the asset given (cash or in-kind) and the nature of the charity (public or private, such as a DAF or family foundation). The amounts of qualified gifts beyond the limitations typically can be carried forward and used, subject to the same limitations, in the following five tax years.
There are multiple forms of charitable giving entities. Due to their ease of creation and low-maintenance, donor-advised funds are a popular choice. As shown, there is flexibility on the type of assets which can be contributed to a DAF, as well as on the timing of distributions from a DAF. For many families, the lesser control is a fair trade-off for the simplicity of the DAF.
This material provides information of possible interest to Glenmede Trust Company clients and friends and is not intended as investment, tax or legal advice. Any opinions, recommendations, expectations and/or projections expressed herein may change after the date of publication. Information obtained from third-party sources is assumed to be reliable but may not be independently verified, and the accuracy thereof is not guaranteed. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Clients are encouraged to discuss any matter discussed herein with their tax advisor, attorney, or Glenmede Relationship Manager.