As investors, charitable giving can be one of the most personally rewarding strategies we have available. Providing aid to our favorite charities as part of our overall financial plan is a compelling opportunity on many levels. Still, navigating our charitable goals and the complexities of planning, organizing and disbursing grants while maximizing the accompanying tax benefits can feel daunting. Fortunately there are methods to streamline the process for the philanthropically inclined. Donor Advised Funds (DAFs) are a charitable investment vehicle that has grown exponentially in popularity in recent years. DAFs offer an efficient and simplified way to make charitable gifts over a long period of time, while granting an immediate tax advantage to donors. At Rockland Trust, we have recently partnered with a leading non-profit sponsoring organization to offer in house management of Donor Advised Funds to our clients. Below, we will cover some of their basics.
What is a Donor Advised Fund?
A Donor Advised Fund is an agreement between a donor and a host organization (the fund). It is a charitable investment account that gives the donor the right to advise the fund on how grants to charities will be made from their contributions. Contributions are generally tax deductible in the year that they are paid to the fund. Though they can bear the donor's name, donor advised funds are accounts held by the fund. Distributions are typically identified to the recipient as being made from a specific donor’s account, unless anonymity is requested.
During their lifetime, donors can make ongoing, non-binding recommendations to the fund as to how much, when and to which charities grants from the fund should be made. There are no annual payout requirements when using a DAF. The below chart illustrates the process.
Tax Advantages
A donation of appreciated stock to a DAF is a common method of funding that has notable benefits to both the donor and the charity. By donating stock directly, the capital gains taxes that would have been incurred on a sale are eliminated. The donor is then eligible for a tax deduction of the full fair market value of the asset on the date of donation, limited to 30% of the donor’s adjusted gross income. Any amount that cannot be deducted in the current year can be carried over and deducted for up to five succeeding years. And because you donated before selling and contributing the net cash proceeds, the charity now also receives 100% of your stock’s value as your gift.
Let’s use the example of Microsoft (MSFT), an appreciated security in many of our portfolios. 500 shares of MSFT purchased for a cost of $60,000 five years ago would be worth over $200,000 today. If you were to sell these shares at the highest capital gains rate of 23.8%, $33,320 in federal taxes would lower both your deduction and your charitable donation. In other words, a charitable donation and a tax deduction of $200,000 from a direct gift of stock would be reduced to $166,680 by instead choosing to sell and contribute the net cash proceeds. The difference in your income tax savings could total over $12,000 at the top tax bracket.
Further, the investment of the fund creates an opportunity for additional tax free growth of your charitable assets.
Donors can generally take an immediate income tax deduction for charitable contributions to a DAF if the donor itemizes deductions on their federal income tax return. For cash gifts, the deduction is limited to 60% of AGI. The five year carryover for amounts in excess of this limit also applies to cash.
There are no federal gift tax consequences due to the charitable gift tax deduction. Federal estate tax liability is also minimized with every contribution since donated funds are removed from the donor's taxable estate.
Establishing and Maintaining a DAF
One of the main advantages of a DAF is the simplicity in setting up an account. First, the donor signs a letter of understanding with the administering organization, establishes and names the account. Once the setup is complete, the donor makes a minimum gift of assets. The initial minimum contribution of $25,000 may include cash, stocks, mutual funds and often times closely held securities. Contributions can be made as frequently as desired, however it is important to note that they are irrevocable. Upon death, the donor may direct that grants be made to charities named in their estate’s legal documents. The donor may also designate surviving family to recommend grants.
In summary, DAFs provide a flexible and more accessible solution to support your preferred charities at the pace of your choosing. There is a current year income tax deduction for the assets you contribute, the ability to donate appreciated assets without incurring capital gains taxes and the potential for continued tax free growth. If you are interested in discussing if Donor Advised Funds are right for you, please contact your Relationship Manager.
