What Is a Donor-Advised Fund?
When a donor invests certain assets in a charity over time, it’s known as a donor-advised fund (DAF). This fund is managed and administered by a third-party institution. There are various reasons why an individual, family or organization might invest in a DAF. Aside from the anonymity and opportunity to have a charitable legacy, DAFs allow donors to receive tax deductions. These benefits help make DAFs one of the fastest-growing forms of philanthropy. Before setting up a DAF, it’s important to understand how they work and differ from other charitable options, their potential drawbacks and the necessary steps to create one.
Donor-Advised Fund Definition
A DAF is a charitable investment account. Instead of donating directly to a charity, the donor sets up an account managed by a sponsoring organization. Although the organization maintains the account, the donor can decide where and when to donate the funds. Donors can be individuals, families or organizations.
According to the Internal Revenue Service (IRS), the sponsoring organization must be a section 501(c)(3) organization. Unlike other donations, the donor can decide to release DAF grants to IRS-qualified charities later but get tax deductions when they make the contributions to the account.
History of Donor-Advised Funds
The New York Community Trust introduced the first-ever DAF in 1931. This philanthropic method grew in 1991 when Fidelity Investments became the first commercial DAF sponsor. It was only in 2006 that Congress created a clear definition of DAF and released regulations through the Pension Protection Act.
The IRS created regulations covering organizations established to generate questionable deductions to prevent abuse of the tax advantages. Proof of these arrangements may lead to IRS disallowing deductions and imposing excise taxes on sponsoring organizations, donors and/or fund managers.
Donor-Advised Fund Trends and Growth
Since its inception in 1931, the popularity of DAFs has significantly increased. According to the National Philanthropic Trust, there were already 1,285,801 individual DAF accounts in 2021. Contributions have also increased to $72.67 billion.
The ease of setting up a DAF and its flexibility to donors make it a good option for charity giving. Donors can choose the organization where their funds go and determine when donations will be disbursed.
DAF Grants Grew by 28%
The number of grants via DAFs significantly increased in 2021. There was $45.74 billion worth of grants to various charitable organizations. This sets a new record high.
Throughout the years, total grants have consistently shown an increase. The upward trend continued in 2021. The growth in value of DAF grants shows a 28.2% year-over-year increase. In 2017, there were only $19.72 billion in DAF grants.
DAF Contributions Continue to Rise
Total contributions also showed an increase in 2021, recording an all-time high of $72.67 billion. This is way over the 2020 value, which is $49.58 billion. Year-over-year growth was 46.6%. Annual five-year growth from 2017–2021 was 23.6%. The average rate of increase from 2011–2020 was 18.1%
DAF Accounts Reached Almost 1.3 Million
There were 1,285,801 individual DAF accounts recorded in 2021. This was 28% more than the 2020 total accounts of 1,007,745. The compound annual growth rate in the past five years was 28.5%.
How Do Donor-Advised Funds Work?
DAFs allow individuals to make charitable donations with more flexibility. By setting up a DAF, the donor leaves the management of funds to a sponsoring organization while having control of when and where the funds will be donated. At the same time, the donor immediately receives tax benefits, no matter when the money is disbursed to charity. Depending on the donor, the donation can also grow tax-free through investments.
Why Donor-Advised Funds Can Be a Rewarding Charitable Option
There are various reasons why DAFs are some of the most rewarding charitable options. Aside from allowing you to support IRS-qualified charities of your choice, you can also enjoy tax deductions as soon as you make contributions. It’s important to remember that DAF contributions are irrevocable. You can no longer take back the funds once you deposit them.
Tax Deductions and Management
Donors can immediately claim tax deductions upon the contribution of assets to DAFs. You can avoid capital gains tax and/or deduct the donated assets from your income tax. This helps in making taxes more manageable. Additionally, it’s possible to grow DAF donations tax-free.
Some people prefer to make donations anonymously. DAFs can help with that. You can keep your identity secret when the sponsor organization releases your charity donations.
DAFs allow donors to withhold their donations. For instance, if you’re unsure what charity organizations to help, you may choose to make grants later.
The benefits donors may receive make DAFs an attractive philanthropy strategy. However, there are also potential drawbacks you need to watch out for. Make sure you consider these before deciding to set up a DAF.
Although DAFs offer flexibility, the sponsor organization ultimately controls the DAF account. There are also limitations to tax breaks. For example, you can’t deduct contributions if the sponsor organization is a war veterans’ organization, fraternal society or nonprofit cemetery company. If there’s no acknowledgment that the sponsoring organization has exclusive legal control of the DAF assets you’ve contributed, you can’t claim tax deductions for your contributions.
What Can Be Contributed to a Donor-Advised Fund?
There are different types of assets you can contribute to a DAF. While these may vary depending on the sponsoring organization, certain assets are commonly accepted.
Most DAF-sponsoring organizations accept cash contributions. These can be one-time deposits or recurring contributions.
By donating non-cash assets, such as a life insurance policy, you can preserve more funds as it may qualify for exemption from capital gains tax.
Stocks, Bonds and Mutual Fund Shares
Donors can transfer assets held for more than a year, such as stocks, bonds and mutual fund shares.
Some DAFs accept new contributions, such as cryptocurrency. In such a case, the donor can get tax deductions equal to the fair market value of their cryptocurrency.
Types of Donor-Advised Fund Sponsors
The IRS defines DAF sponsors as section 501(c)(3) organizations. But generally, there are three main types of DAF sponsors — community foundations, single-issue charities and national DAFs.
As the name suggests, community foundations are independent nonprofits created by and for a specific local area.
These nonprofit organizations typically work in a certain topic area, such as particular identities, causes or faith. Examples of these include religious organizations, hospitals, rotary foundations and universities.
There are also DAF-sponsoring organizations created solely for DAFs. Some of these may be charitable arms of for-profit financial service providers.
Donor-Advised Fund Strategies to Optimize Tax Benefits
Many may think of a DAF as a tax management and philanthropy strategy for wealthier individuals or those who belong to higher federal tax brackets. This misconception may be due to some sponsoring organizations requiring minimum contributions. However, most individuals can use it to gain tax benefits while making charitable deeds. What’s important is you know how to optimize the benefits.
Here are some tips you find helpful:
Donate to a DAF Before the End of the Year
Even without a charity organization chosen, you can start building a DAF. To gain tax deductions immediately, make sure you contribute assets to your DAF before the end of the year.
Contribute Cash From Other Assets
Review your securities. You can sell them or use the appreciated value to start a DAF. You may also opt for non-liquid assets like artworks, real estate and other collections as contributions.
Donate and Give Multiple Smaller Gifts Over a Series of Years
You can make recurring contributions and claim tax deductions every time you make contributions.
Opening a Donor-Advised Fund: Step-by-Step Instructions
Having a DAF account can help you plan your charitable donations to suit your goals. However, it’s important to find the right provider and charity organization. Taking the right steps can help you avoid making mistakes. Additionally, it can help you have a smooth experience.
Below is a simple guide to help you start your DAF journey.
1. Compare and Select the Right DAF Provider
There are different types of DAF sponsoring organizations. Each one offers advantages. They may also have specific requirements and fees. Make sure you compare your options well to find the right DAF provider based on your financial situation and charity goals.
National Philanthropic Trust
$0 for core account
$250,000 for professionally
$100 or 0.6%
0.60% annually for core
Quarterly account fee for
Based on average daily
0.03–0.77% (depends on the
2. Check Fees
There may be fees involved. DAF sponsors may charge administrative and investment fees. Some may also have maintenance fees.
Depending on the sponsoring organization, there may also be regulations on how fees are calculated. Typically, higher contributions may have cost more. Make sure you consider these before starting a DAF account.
3. Fund and Contribute to Your DAF
Once you decide on a DAF sponsor, you can start making contributions. Some providers may have a minimum initial contribution requirement. There may also be organizations that restrict what type of assets you can contribute. Generally, you can deposit cash, stocks, mutual funds, life insurance policies and other investments like cryptocurrency.
4. Claim Your Tax Deduction
You can immediately claim a tax deduction upon depositing your contribution. Make sure you itemize your taxes and deductions properly. Deductions depend on the type of asset. For instance, the limit for itemized deductions on charitable cash contributions is 60% of your adjusted gross income (AGI).
5. Make Investments and Help Your Donation Grow
Ultimately, control and maintenance of DAFs are responsibilities. However, donors remain as advising parties. For example, you can choose where to invest your funds. That said, your options are limited to the options provided by your chosen DAF.
6. Pick Charities
Decide on what charitable organizations to support. Donors typically choose where to donate their funds. Ensure you review that your chosen charities are IRS-qualified.
Donor-Advised Funds vs. Other Charitable Options
A DAF is only one of the many charitable options available. The best way to donate depends on your preference and goals. If you think a DAF isn’t right, you can opt for private foundations or charitable trusts instead.
Use the table below to review varying options.
Donor-Advised Funds vs. Private Foundations vs. Charitable Trust
- Managed by a DAF-sponsoring organization
- DAFs are sponsoring organizations
- Donor investments vary depending on the sponsoring organization
- Managed by the foundation’s trustees and/or directors
- A separate legal entity established by an individual, corporation or family
- Management of investments is the responsibility of the donor
- Donor has complete control over grants
- An irrevocable trust, which can’t be changed or canceled upon establishment
- Legal help is necessary to set up a charitable trust
Expert Insight on Donor-Advised Funds
Interested donors, especially first-timers, may find the whole ordeal a bit challenging. MoneyGeek spoke with some industry leaders to provide expert insights you can use to determine whether a DAF is right for you and how you can maximize the benefits DAFs offer.
- What tips can you share with individuals who want to maximize the benefits that donor-advised funds offer?
- What’s the most important factor(s) to consider when deciding whether to create a donor-advised fund or not?
- How can an individual decide what type of donor-advised fund is best for them?
Certified Financial Planner (CFP) at One Degree Advisors
Assistant Professor of Accounting at Arkansas State University
Certified Financial Planner and Founder of ohanthemoneydoctor.com
Financial Planner at Millenial Wealth, LLC
Starting a DAF can be a bit overwhelming, especially with the available options. Fortunately, there are various resources you can use to help you make well-informed decisions.
- American Endowment Foundation: Use this list of questions to determine whether a DAF sponsor is suitable for your charity goals.
- Charitable Giving Tax Savings Calculator: Get an estimate of potential tax savings.
- Charity Action Plan: Start planning your charity action plan using this online worksheet.
- Community Foundation Locator: Select your state or use the interactive map to determine what accredited community foundations serve your area.
- Federal Trade Commission Consumer Advice: Get tips on how to choose the right charitable organization. Find out the red flags you should watch out for.
- Give.org: Find a certain charity and check its accreditation using Give.org’s online search tool or alphabetical list of charities.
- Nine Questions You Should Ask Every Nonprofit: Choose the right nonprofit organization with the help of these questions.
- Philanthropy Roundtable Policy Primer: Learn more about donor-advised funds as a charitable giving tool using this comprehensive guide.
- Tax Exempt Organization Search Tool: Use the IRS’ online search tool to find tax-exempt organizations you can choose from.
- Tax Foundation: Stay updated on tax changes.
- FBI.gov: Access various resources on reporting charity scams.
About Nathan Paulus