Charitable Giving and Donor-Advised Funds: A Comprehensive Guide

This is week four of our 7-week series. If you wish to read our previous articles, you can chose them from the list below:

1. Tax Planning: Essential Strategies for Long-Term Success 

2. Why Required Minimum Distributions (RMDs) and Qualified Charitable Distributions (QCDs) Matter to People of All Ages

3. Understanding Health Savings Accounts (HSAs): A Comprehensive Guide

Charitable giving has long been a pillar of social good, enabling individuals, families, and corporations to contribute to causes they care about. Over the years, various methods of giving have evolved, from throwing a twenty-dollar bill into the offering plate on Sunday to complex trusts and foundations.

One of the more recent innovations in this space is the donor-advised fund (DAF), which has become a popular vehicle for philanthropy. This article explores the landscape of charitable giving, the role of donor-advised funds, and how they work.

The Importance of Charitable Giving

Charitable giving is crucial for several reasons:

1. Supporting Nonprofit Organizations: Nonprofits rely on donations to fund their operations, whether they focus on health care, education, environmental protection, or social services.

2. Promoting Social Good: By donating, individuals can directly influence societal changes, from reducing poverty to improving public health.

3. Potential Tax Benefits: Charitable contributions may come with tax deductions, incentivizing individuals and corporations to give more generously.

4. Personal Fulfillment: Generosity is a critical component to living a fulfilled life. Many donors find personal satisfaction and a sense of purpose in giving to causes that align with their values and passions.

The Tax Challenge with Generosity

While the direct giving approach is the easiest way to get your money into the hands of the organizations that need it, this approach generally leads to limited tax benefits.

With the standard deduction set at $29,200 for married couples filing a joint return (and $14,600 for individual filers), most direct gifts provide no personal tax benefit. That’s because the combination of the charitable giving, mortgage interest and “SALT Tax” (state and local property tax capped at $10,000) have to get above the standard deduction to justify itemizing deductions on a tax return.

For families who own their home free and clear (ie. no mortgage), the first $19,200 of charitable giving simply gets them back to the standard deduction. That means that a generous family who gives away $20,000 in 2024 (assuming they own their home and reside in the 24% tax bracket) will get a whopping $192 tax benefit for giving away $20,000.

What are Donor-Advised Funds?

Donor-advised funds (DAFs) are philanthropic investment accounts that allow donors to make a charitable contribution, receive an immediate tax deduction, and then make grants from the fund over time. DAFs have surged in popularity due to their flexibility, ease of use, and the financial benefits they offer.

How Donor-Advised Funds Work

1. Opening a DAF: A donor creates a DAF account with a sponsoring organization, which is typically a public charity, community foundation, or financial services firm with a philanthropic arm.

2. Contributing to the Fund: The contributed assets are able to be invested in various options offered by the sponsoring organization. This allows the investment to grow tax free, potentially increasing the amount available for grants. 

3. Investment of Assets: The contributed assets are invested in various investment options offered by the sponsoring organization. The investment grows tax-free, potentially increasing the amount available for grants.

4. Recommending Grants: Donors can recommend grants to qualified nonprofit organizations at any time. The sponsoring organization conducts due diligence to ensure the recipient organizations are eligible.

5. Ongoing Management: The sponsoring organization handles all administrative tasks, including record-keeping, due diligence, and grant disbursements.

Benefits of Donor-Advised Funds

1. Tax Efficiency: Donors receive an immediate tax deduction when they contribute to the DAF. This is especially advantageous for those who contribute appreciated assets, as they can avoid capital gains taxes.

2. Simplicity: DAFs simplify the giving process. Donors can make a single contribution and then recommend grants to multiple charities over time without the administrative burden of managing individual donations.

3. Flexibility: DAFs allow donors to time their charitable contributions to coincide with favorable tax years, while also giving them the flexibility to distribute grants over time.

4. Anonymity: For donors who prefer to remain anonymous, DAFs offer a layer of privacy, as grants can be made without disclosing the donor's identity.

5. Legacy Planning: DAFs can be a part of a donor's estate planning, allowing them to create a lasting philanthropic legacy by involving family members in grant-making decisions.

   
   

How can Donor-Advised Funds Help Reduce Your Tax Burden?

Take the example of the family above who gives away $20,000 each year to get a $192 tax benefit. Over 3 years, their $60,000 of giving would provide them around $600 in total tax savings. That same family can choose to put $60,000 in their Donor Advised Fund (DAF) in 2024, and give away that $60,000 in the DAF over 2024, 2025 and 2026. They will capture $9,792 in tax benefits in 2024, then take the standard deduction in 2025 and 2026. They give away the same amount of money over the three-year period, but they capture nearly $9,000 of additional tax benefits by simply giving in a more strategic manner. 

Considerations and Criticisms of Donor-Advised Funds

While DAFs offer many benefits, there are some considerations and criticisms to keep in mind:

1. Fees: DAFs often charge administrative and investment fees, which can reduce the amount available for charitable giving. Donors should be aware of these fees when establishing a DAF.

2. Lack of Control: While donors can recommend grants, the final decision rests with the sponsoring organization. That is why it’s critical to know the sponsoring organization.

The Future of Donor-Advised Funds

The popularity of donor-advised funds is likely to continue growing due to their flexibility, tax advantages, and the increasing focus on strategic philanthropy. As more individuals and families seek to align their charitable giving with their personal and financial goals, DAFs will remain an attractive option.

Conclusion

Donor-advised funds represent a powerful tool for modern philanthropy, offering a blend of flexibility, tax efficiency, and simplicity. For donors looking to make a meaningful impact while also maximizing their financial benefits, DAFs provide a compelling option. As with any financial decision, it's important for donors to carefully consider their goals, consult with tax-centric financial advisors, and understand the implications of using a donor-advised fund as part of their charitable strategy.

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