For such donors, a donor advised fund (DAF) may be the best solution. While not a new charitable giving tool, donor advised funds have become one of the most popular giving techniques in recent years. Contributions as a percentage of total individual giving have more than doubled between 2010 and 2017, probably because these funds offer a variety of donor benefits, including control, anonymity, potential tax savings, and ease of giving.
A donor advised fund is a contractual relationship between the donor and a sponsoring organization. The donor makes a charitable contribution to the sponsoring organization, which then owns the assets and administers the fund. The donor retains advisory privileges over the charitable funds distributed from the account. This arrangement lets the donor qualify for an immediate income tax deduction for the amount of the contribution even though funds won’t be distributed until later, at which time the donor can influence distributions to support a chosen charity. A donor advised fund offers unique versatility in allowing a donor to give what is most favorable at the time that works best for the donor.
Forbes magazine compared donor advised funds to a traditional brokerage:
Think of a donor advised fund (DAF) account as kind of a tax-advantaged charity brokerage account. The sponsoring organization is a charity that holds and manages donors’ contributions—cash, stocks, bonds, real estate, even business ownership—for the purpose of making grants to other charities, once (or if) the donors tell them to do so.
The innate flexibility of donor advised funds provides donors options that allow for some level of control, and arguably provides customized charitable giving options that let donors “donate their way.”
For the donor, there are many benefits to donor advised funds:
For certain donors, the flexible nature of a donor advised fund may be almost as important as the tax deduction. Consider a typical charitable donation—let’s say a donor writes a check to a charity, the charity accepts the donation, and the donor qualifies for an income tax deduction in the year of the gift. The gift is complete and the donor and charity each go their merry way. With a donor advised fund, however, the donor has more options. Let’s look at two examples:
Example: Brian took a gamble on an initial public offering of a new stock, and it paid off. He is going to owe significant income taxes this year and would like to use the stock to make a charitable donation so that he can make use of the charitable income tax deduction. However, he does not have a particular charity in mind yet. He has no time to research worthy charities and doesn’t want to rush into a decision. For Brian, a donor advised fund provides a way to make a donation, take the income tax deduction now, and then later recommend distributions to particular charities.
Example: Erin is a successful software engineer who will be receiving a series of substantial payments over the next 20 years as a result of her work being licensed. Erin wants to make a charitable contribution to her graduate school, but also wants the contribution to be large enough to allow the school to do something significant. Rather than contribute $10,000 or $20,000 per year, Erin instead contributes the annual cash into a donor advised fund. In 10 years, enough has accumulated that she can make a significant contribution.
Donor advised funds offer a level of control that is often lacking with other charitable giving strategies. For donors who prefer flexibility in their giving but still want an immediate income tax deduction, a DAF may be the answer. As a professional advisor, understanding the basics of donor advised funds (including requirements, restrictions, benefits and shortcomings) will allow you to effectively counsel clients. Ideally, informed advice will lead clients away from inflexible gifts to transactions that are financially successful and personally satisfying to donors.