Donor Advised Funds: A Win-Win All Around!
Do you regularly donate to organizations such as a religious institution, alma mater, or a 501(c)(3) charity? Good for you!
Do you own investments with low cost basis that you'd like to sell but don't want to pay the capital gains tax that will result? Even better!
A Donor Advised Fund may be the perfect vehicle for you!
A Donor Advised Fund (DAF) can be set up with most major brokerages. You make a tax-deductible contribution of cash, stock, mutual fund shares , or even non-publicly traded assets. The amount of the tax-deduction is based on the current market value of those assets...not the price that you originally paid for them.
For example, say you own 1000 shares of a stock you bought 10 years ago for $2/share ($2,000) and it's now worth $20/share ($20,000). If you use those shares to fund a DAF in 2023, you would have made a $20,000 tax-deductible donation in 2023. Also, you didn't have to pay any capital gains tax. Yay!
One thing to consider is that once you make that donation you do not have access to those assets any longer. Therefore, if down the road you need some of that money back for an emergency you'll have to look elsewhere for the cash.
So, now what happens to the money in the DAF? It's going to sit there appreciating in value (hopefully!) until you decide what organization(s) gets it. If you want $100/year to go to your local animal shelter, $300/year to go to the Red Cross, $500/year to go to your alma mater, and $2,000/year to go to your church then you set that up with the administrator of the DAF.
Did you notice that you get the full tax-deduction in Year 1, but the charitable donations can be spread out over many years? Pretty cool, huh?
You may have noticed one potential downside: Even if the assets in the DAF continue to appreciate in value before they're passed along to your charity of choice, you won't get the tax-deduction of that appreciated amount. [On the other hand, if the donated assets declined in value, you were able to claim the higher-valued tax-deduction in the year you funded your DAF.]
Things to consider when establishing a DAF…
- The higher your marginal tax bracket, the more tax savings a DAF offers. Since you’ll likely be in your highest tax bracket the last year before you retire, that’s a good time to open a DAF.
- The DAF tax savings is larger the greater the difference between how much is contributed to the DAF and the amount of your tax deduction. The standard deduction ($29,200 in 2023 for married filing jointly) is set to decline back to the 2017 amount of $12,700 for married filing jointly in 2026, unless Congress does something. Therefore, it may make sense to wait until 2026 to contribute to a DAF to take advantage of the potentially greater difference between your deduction amount and the amount you contribute to a DAF.
- Different financial institutions who offer DAFs have different minimums that you’re allowed to donate at a time. For example, Vanguard requires you to donate at least $500 at a time to a charity while Fidelity’s minimum is only $50. (At least, last time I looked. 😊)
Donor Advised Fund aren't for every situation, but they can be a perfect solution for some. I recommend you speak with your tax-advisor to see if DAFs are a good fit for you.