Donor-Advised Funds

Charitable and tax-planning efforts get a boost from this unique, flexible opportunity.

By Brendan Coffey

While private foundations were the great charitable vehicles of the 20th century, donor-advised funds (DAFs) are becoming the 21st-century philanthropic solution of choice. Donations through DAFs have been rising 30% a year since 2004, four times the annual increase in the rate of giving, according to philanthropic consulting foundation Giving USA. There are now 100,000 DAFs nationally with $17.5 billion in assets, or gifts, which go to every type of eligible charity, from food banks to museums to educational institutions.

For those who know the unique advantages DAFs offer, their growing popularity won’t come as a surprise. DAFs provide people across the wealth spectrum the strengths of a private foundation as well as superior flexibility and tax efficiencies on gifts of cash, appreciated securities and even closely held shares and property.

"We recommend people think about a donor-advised fund because of three advantages: It disconnects the timing of the deduction from the timing of the distribution; it’s a receptacle for advanced estate-planning techniques; and it’s a tool to teach the next generation about philanthropy and make giving a family decision," says Johnne Syverson, an independent financial adviser and president of the International Association of Advisors in Philanthropy (AiP).

Simplicity and Flexibility for Little Cost

A donor-advised fund is a charitable fund in your name administered by a nonprofit, such as a charitable organization founded by investment companies, a community foundation or a university. As a donor, you have a DAF set up in your name; you decide when and how much to donate to the fund; and you direct to which 501(c)(3) nonprofits you want to make disbursements. The administrator vets charities for IRS eligibility, sends out the checks on your request and even manages the investment of your charitable assets based on your guidance.

The simplicity of a DAF stands in contrast to private foundations, which require creating a board of trustees, hiring an administrator and adhering to strict regulations over how the foundation’s money can be invested and disbursed. Given the complexity of compliance, financial advisors generally say it’s not worth creating one with less than $1 million in assets. Then there is the time-consuming task of evaluating gift requests, running board meetings, filing public documents and ensuring that annual disbursements meet the IRS requirement of 5% of assets.

In many cases, a DAF can be started with as little as $5,000; gifts can be as little as $100; and there are no annual disbursement requirements or public filings. You can even give through the DAF anonymously, a feature prized by those who want to avoid publicity or further solicitations. All of those services come with low expenses, typically less than 1% of assets under management. Those who have $500,000 or more in DAFs find their expenses drop as a percentage of assets, and they often gain the option of naming their own financial expert to manage the assets.

"Consumers want to do things themselves, and they want to do it easily and inexpensively," says Kim Wright-Violich, president of Schwab Charitable Fund, a national DAF that has disbursed over $1 billion through 200,000 donor-recommended grants to 50,000 public charities since its founding in 1999. "They want to preserve their time and take the complexity out of giving without surrendering decision making. You get all of that with a donor-advised fund."

DAFs provide people across the wealth spectrum the strengths of a private foundation as well as superior flexibility and tax efficiencies on gifts of cash, appreciated securities and even closely held shares and property.

Unique Tax Advantages

The ability to combine charitable giving with tax efficiency is also a hallmark of donor-advised funds. Cash donations to DAFs can be deducted up to 50% of adjusted gross income, as opposed to 30% for donations made through private foundations. Gifts of appreciated assets, like stocks, are deductible up to 30% with a DAF, but only 20% for a private foundation. Both DAFs and private foundations enjoy a five-year carry-forward provision for excess deductions.

On top of the income deduction, gifts to a DAF allow you to take an immediate tax deduction for the market value of the donation, but you don’t need to decide when or where to donate that money. At year’s end, when work obligations and family gatherings dominate one's time, it allows the luxury of gaining a needed tax deduction without settling on a charity. It also allows wealth to build over a longer period of time toward a larger gift. "There is no time like the present to make a contribution and get your tax deduction," says Sarah C. Libbey, president of the Fidelity® Charitable Gift Fund, which has donated over $8 billion in funds to 122,000 charities since its founding in 1991. "You can make your contribution and take your time in understanding how you want to grant out the money as you see fit," she adds. "You give, you grow, and then you grant."

Through donor-advised funds, investors can find the opportunity to eliminate sizeable capital gains bills on appreciated assets as well. For example, investors holding low-cost-basis stock with a capital gain of $100,000 face a large tax bill if they try to diversify. By donating some of the stock directly to the DAF, they earn a deduction equal to the market value of the stock. In this example, donating stocks with $15,000 of gains to the DAF would more than offset the $12,750 in qualifying long-term capital gains tax due on the remaining $85,000 of gains.

Flexibility With Illiquid Assets

The ability to donate appreciated assets to a donor-advised fund isn’t limited to publicly traded securities. Increasingly, DAFs accept illiquid assets such as closely held stock, real estate and even, in one recent instance, domain names.

The opportunity to gain a deduction without creating a taxable event is something a growing number of executives are taking advantage of. William Schawbel, chief executive officer of Schawbel Corporation in Bedford, Mass., gifts shares in his company to his DAF with the Boston Foundation. Shares of the diversified company, best known for its ThermaCELL portable power technology, finance his interest in fostering public education and women entrepreneurs. Under an agreement with the foundation, DAF shares are redeemed for cash only when a division of the company is sold or Schawbel accumulates enough cash to buy back the shares, whether that is months or years later. "I accomplish a number of things at the same time," explains Schawbel."By putting it in a donor-advised fund, I create a not-for-profit foundation without all the administrative work. The deduction takes place immediately without cash flow going out… [and] funds [go] toward organizations that can give me the emotional return on investment I want." Over the years, he has donated approximately 7% of Schawbel Corp. to his DAF and disbursed $3 million to good causes.

Gifts of illiquid assets are more complex. For one, the DAF administrator will need a road map to outline how the shares will be turned into cash, which can then be disbursed to charities. Also, the IRS requires independent appraisals to be conducted for all noncash gifts worth over $5,000. In the case of harder-to-value assets like property or shares in a closely held company, an appraisal can run as high as $25,000, according to Lawrence P. Katzenstein, a partner in the St. Louis, Mo., office of Thompson Coburn LLP. That means that gifts of assets that aren’t publicly traded often need to be larger than cash minimums to justify the time and expense. Still, DAFs are becoming known for their ability to handle illiquid assets. Both Fidelity and Schwab, for instance, are willing to work with donors to craft tax-deductible contributions involving private equity, real estate, tangible personal property and other assets.

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