When Is It A Smart Move To Open A Donor Advised Fund?

Would you believe me if I told you that there is a tool out there that could allow you to increase your charitable giving without any change to your bank balance?

Donor Advised Funds (DAFs) have this potential. For years, DAFs have carried a connotation of being a way that only the wealthy used for charitable giving. The reality is that it can be a wonderful tool for many families earning middle incomes, too. 

What Is A Donor Advised Fund?

A DAF is, in the eyes of the IRS, a separate legal entity with special tax treatment. Dollars placed into a DAF are tax-deductible in a similar way as giving to your church or favorite nonprofit is. The difference is that a DAF doesn’t do any direct charitable work of its own. However, you as a contributor to the fund can decide how much, when, and where those funds get distributed for charitable purposes. The DAF then donates this money to the charity of your choice and on your behalf. This includes gifts to any church or non-profit, provided it has a 501(c)(3) designation.

Why Donor Advised Funds Can Be An Effective Tool

Tax-Saving Strategy

The important distinction here is that the charitable giving event occurs when money is placed into the fund, NOT when you elect to have it distributed out to your favorite charity or your church. Why does this matter? It calls the impact of charitable giving into play when it comes to itemizing vs. taking the standard deduction on your taxes. 

Millions of middle-class Americans stopped itemizing once last year’s changes in the tax code raised the standard deduction. That means any charitable giving from these households, while meaningful for other reasons, no longer mattered for tax purposes. This is where a DAF can work its magic, which is best demonstrated through an example.

How The Tax Benefits Play Out In Real Life

Suppose the Johnson family is one of the millions of families mentioned that once itemized but under the new tax code no longer does. Suppose also that they intend to donate $12,000 to their church each year for the next three years. 

They could write a personal check for $1,000 each month to accomplish their goal. However, each year at tax time they’d add this number to their mortgage interest and other allowable deductions (which total $5,000) only to realize that, at $17,000 of deductions, they’re still well below the standard deduction of $24,400 for married taxpayers filing jointly. 

Instead, they decide to move $36,000 into a DAF over the course of the first year. Because the charitable tax event happened this year, they are now able to deduct the entire amount. Added to the $5,000 in other deductions, they are now $16,600 above the standard deduction ($36,000 + $5,000 - $24,400 = $16,600). Depending on their tax bracket, they will save about $5,000 or more on their taxes this year. For the next 36 months, they can tithe to their church out of their DAF by making the same $1,000 gifts as they did before.

The Johnsons could have skipped the DAF and written a $36,000 check to their church at once. This would have had the same effect on their taxes, but it would have an odd effect on them and on their church. That is, they wouldn’t have that same act of tithing each month that they feel is important and the church’s budget would get thrown off by the big outlier gift.

Prioritizes Giving

While many get into a DAF for tax reasons, I find that many who do also end up discovering that it brings some increased intentionality to their giving. They are now proactively looking at their finances and making a thoughtful decision about how and where they want to be generous. Some intentionally leave space for ‘spontaneous giving.’ That is, there is money set aside simply to react to new needs or opportunities they will become aware of and passionate about in the future.

Simplification Of Donations

DAFs can keep your giving simple. All of your giving happens in one spot. With a DAF, there is no longer a need to keep track of multiple tax receipts. It’s also easy to always see where you are with your giving throughout the year. There is no longer a need to look through your bank accounts and credit card statements for each and every charitable transaction you made in order to determine how much more you want to give. A DAF naturally gives you a separate and dedicated account for all of your charitable giving.

Some Drawbacks to Consider

Requires Cash Up Front

Not every family can come up with $36,000 to fund a DAF as the Johnsons did. While DAFs can be funded with lesser amounts than this, there often still are minimums to open an account. It certainly requires a fair amount of liquidity for it to be an effective tax strategy.

Most Have Fees

DAFs generally carry small administrative fees and therefore aren’t 100% efficient. Like anything, the fees and rules vary from company to company. Make sure to shop around to understand the different fee structures and make sure the one you choose makes sense for you.

Ownership of Funds

It is important to note that the funds are technically no longer ‘yours’ as soon as you transfer them into a DAF. This can be hard to understand because you still have a choice over where the money goes… for the most part.

When you go back to the administrator of your DAF to tell them where you’d like donations to go you are actually just ‘recommending’ that a grant be made to a specific organization. Any well-run DAF (and most are) honors that recommendation and quickly disperses the money. 

Just know that they legally don’t have to. It is very rare for a DAF not to honor grant recommendations up to the amount contributed. In fact, I haven’t heard of it not happening, but it does mean that you should research the company you are considering opening a DAF with and choose one that has a strong reputation.

Donor Advised Funds That I Recommend

National Christian Foundation (NCF) and Fidelity Charitable are two DAF providers that I recommend. Both have stood the test of time and with good reason. Fidelity Charitable has low fees, an easy online system to navigate, and good investment options. They call their DAFs ‘Giving Accounts.’

NCF is also very competitive with their fees, has outstanding service, and a wonderful mission centered around Jesus. Check out their website for more information or to get started. They call their DAFs ‘Giving Funds.’

Who Should Have A DAF?

I’d recommend that any household that gives charitably but doesn’t itemize should at least look into whether a DAF can be a good tool for them. Generally speaking, a DAF requires a one-time cash investment of $5,000 or more, but not always. Plus, even if you don’t have that kind of cash now, it’s something to be aware of and perhaps work towards saving up for. If you are planning to continue to be generous and philanthropic, you may want to intentionally save to fund a DAF next year or in the future.

The end of the calendar year is around the corner. Now is a great time to revisit your giving and consider funding a DAF. You can still get the tax break for 2019 and get grants out to your church and/or charities before the end of the year. As you saw, a DAF takes some planning and strategy, which is something your financial adviser can help you with. If you don’t already have an adviser, as always, I’m here to help. If you want help setting up a DAF or just have more questions, schedule a call with me today.

About Wacek Financial Planning

Founder Ben Wacek is a fee-only Certified Financial Planner™ and Certified Kingdom Advisor® who has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. If you’d like to learn more about Wacek Financial Planning, please visit www.wacekfp.com.

 

Photo courtesy of Olichel on pixaby.com

 

 

Tags: