A Popular Tax-Advantaged Of Donor-Advised Funds

Nov 13, 2023 By Triston Martin

Although a donor-advised fund appears to be reserved for the very rich, anyone who makes philanthropic contributions can take advantage of its benefits. According to Fidelity Charitable, the donor-advised fund is the fastest-growing charitable giving vehicle in the United States because it is one of the most tax-efficient methods to send money to charity.

A donor-advised fund (DAF) is a giving account that allows a donor to make several annual gifts to a designated charity. Donor-advised funds are simple to set up and keep up with, giving contributors a way to reduce their tax liability while still making charitable contributions. While you deliberate over which nonprofits to support, the fund can be invested in and allowed to grow.

The inner workings of a donor-advised fund

A donor-advised fund (DAF) is a charitable giving vehicle in which an individual or group contributes to a fund sponsor (often a nonprofit organization or a financial services provider like Charles Schwab or Fidelity Investments). The donor receives a tax deduction in the year of the fund's inception, and the fund sponsor can disperse the funds each year based on the donor's instructions.

Richard Mills, an estate planning attorney at the Michigan law firm Marcoux Allen, compares the fund to a "tax-free pot that stores charity gifts."

Donors should understand that their contributions are final once the fund has been established. The rules for making contributions to the fund are determined when it is set up. However, the sponsor is ultimately responsible for how the money is spent, and the donor's input on how the funds should be allocated is not binding.

Mills argues that it is unusual for a sponsoring organization's board to use its variance powers to go against the donor's wishes.

However, to benefit from a lower tax rate on these funds, you must itemize your deductions, which will only be possible if your total removals in 2022 are more than $25,900 for a married couple or $12,950 for an individual taxpayer. If your contributions are less than those amounts, the net tax advantage of using a donor-advised fund will be zero.

The potential benefits of a donor-advised fund

Mills argues that the popularity of donor-advised funds has skyrocketed in the last 15 years since setting one up is as simple and affordable as starting any brokerage account.

According to Mills, financial planners recommend customers incorporate them in their plans, and lawyers include them in their clients' wills. He explains that they are simpler and cheaper than alternatives like establishing a private foundation or a charitable trust.

However, this form of fund offers a plethora of additional advantages that may make it the best option for donors.

Accounting for Taxes

Many taxpayers may be enticed to set up donor-advised funds due to the possibility of a shift in the tax landscape. The Biden administration has proposed the step-up in cost basis on inherited assets and decreasing the amount of money that can be exempt from the estate tax, in addition to hiking capital gains tax rates on wealthier taxpayers.

Even while it's still hard to tell what a Biden government would do, they ran on a platform of raising taxes on the wealthy, so a well-thought-out strategy could end up lowering your tax bill. Regardless of the tax climate, a donor-advised fund can benefit.

According to Kristi Hanson, director of taxable research at NEPC, an investment consulting business based in Boston, "investors may contemplate investing donor-advised funds in 2021 and beyond with low-cost-basis stock if basis step-up is repealed."

Simplicity

With a donor-assisted fund, you may create a single strategy to oversee your philanthropic contributions, and the fund's sponsor will take care of the necessary paperwork.

"Some contributors prefer the simplicity," explains Hammond, "where they can make one charitable gift and monitor one gift receipt, and then have the fund sponsor handle several charity distributions from that fund without the donor needing extra documentation."

Donor-advised funds established through community foundations allow donors to remain anonymous while still taking advantage of their ability to direct the distribution of their charitable contributions.

For first-time or less experienced givers, having a fund's sponsor offer guidance on charitable organizations to support and administrative details of the donating process can be invaluable.

"Other contributors may have a liquidity moment where they wish to devote cash to charity but are confused about which organisations to support," says Hammond. In other words, "the donor-advised fund enables the donor to make the initial donation today and make grants at a later date."

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