What is a Donor-Advised Fund?Submitted by MIRUS Financial Partners on November 9th, 2023
A donor-advised fund (DAF) is a tool created to allow people to deliver significant charitable gifts over a long period. In some ways, it's similar to a private foundation but simplified. A DAF requires less money, time, legal assistance, and administration to establish and maintain. Best of all, a donor-advised fund can offer more significant tax advantages than a private foundation.
A simple definition of a DAF is "an agreement between a donor and a host organization that gives the donor the right to advise the fund on how the donor's contributions will be invested and how grants to charities (grantees) will be made."
Contributions may be tax deductible in the year they are paid to the fund, subject to the usual limitations if they are structured correctly. Though they can bear the donor's name, donor-advised funds are not operated as separate entities like private foundations are but are merely accounts held by the fund. The fund owns the contributions and has ultimate control over grants.
Creating a DAF
It's easy to set up a DAF account. The donor first signs a letter of understanding with the fund, establishes an account, names the account, and recommends an investment strategy. Then, depending on the fund, the donor makes the required minimum contributions of assets, which may include cash, marketable securities, and other types of assets. The required minimum contributions vary from fund to fund but are usually less than those required by private foundations.
During life, the donor (or the donor's designee) can make ongoing, non-binding recommendations to the fund as to how much, when, and to which charity grants from the fund should be made. Additionally, the donor can offer advice to the fund regarding how contributions should be invested. The donor may suggest that, upon death, grants be made to charities named in his or her will or other legal instrument such as a revocable living trust. Or the donor may designate a surviving family member(s) to recommend grants. However, the fund is not obligated to follow any of the donor's suggestions — hence the name "donor-advised fund." As a practical matter, though, the fund will generally follow a donor's wishes. Distributions to grantees are typically identified as being made from a specific donor's account, but they can be made anonymously at the donor's request.
The Difference Between DAFs and Foundations
Private foundations and donor-advised funds are alike in some ways. Both allow a person to take tax deductions now and decide later on whom to give. Both donor-advised funds and private foundations can be named to honor the donor, a family member, or other person.
However, a DAF usually receives contributions from many unrelated donors (though donors' accounts are kept separate), while a private foundation is typically funded by one source (an individual, family, or corporation). DAFs can only offer advice regarding grants and investments. Private foundations provide the donor exclusive control and direction over grants and investments, an attractive feature to some philanthropists.
However, various legal restrictions imposed on private foundations are not imposed on donor-advised funds, and the federal income tax treatment of a donation to a private foundation is less favorable than that afforded to a donor-advised fund. Because contributions to a donor-advised fund are considered gifts to a "public charity," they may allow a greater income tax deduction than contributions to a private foundation. Furthermore, private foundations must distribute at least 5% of their assets annually. Donor-advised funds have no minimum distribution requirement (though some funds follow the 5% rule voluntarily), and donors may be allowed to let their accounts build up tax-free for many years and be distributed only upon a specified date or upon a specified event.
Also, donor-advised funds do not need to fulfill many reporting and filing requirements imposed on private foundations. And because the fund handles any legal, administrative, and filing requirements (including tax returns), the donor is wholly freed from these responsibilities. In addition, since separate accounts within a donor-advised fund are administered as part of the larger host organization, the administrative costs borne by the donor are generally lower than those incurred by a private foundation.
Endowed Funds vs. Non-endowed Funds
Endowed funds only distribute income, not principal. These funds invest a donor's assets in perpetuity for potential growth over time. Because they are permanent, endowed funds provide a lasting memory of the donor's philanthropic nature.
Non-endowed funds permit a donor to make ongoing recommendations for grants up to the entire fund balance (principal and income). Such funds remain non-endowed unless the donor specifies otherwise or until the donor or the donor's designees no longer provide advice to the fund.
A donor can generally take an immediate income tax deduction for contributions of money or property to — or for the use of — a donor-advised fund if the donor itemizes deductions on his or her federal income tax return. The deduction amount depends on several factors, including the contribution amount, the type of property donated, and the donor's adjusted gross income (AGI). Generally, deductions are limited to 50 percent of the donor's AGI. From 2018 to 2025, the limit is increased to 60% for charitable cash contributions to public charities. If the donor makes a gift of long-term capital gain property (such as appreciated stock that has been held for over one year), the deduction is limited to 30 percent of the donor's AGI. The property's fair market value on the date of the donation is used to determine the amount of the charitable deduction. Any amount that cannot be deducted in the current year can be carried over and deducted for up to five succeeding years.
Additionally, donor-advised funds are not subject to the excise taxes levied against private foundations.
Gift and Estate Taxes
There are no federal gift tax consequences because of the charitable gift tax deduction, and federal estate tax liability is minimized with every contribution since donated funds are removed from the donor's taxable estate.
Want to Learn More?
Mirus Financial Partners can help you or your organization explore the benefits of DAFs. Contact Mark Vergenes today to learn more about your options.
Investment Advisor Representative offering Securities and Advisory Services through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker/dealer, and Registered Investment Adviser. Cetera is under separate ownership from any other named entity. MIRUS Financial Partners and Cetera Advisor Networks LLC are not affiliated.