Pros and Cons of Donating to a Donor Advised Fund
Including charities in your estate plan is undoubtedly a win-win proposition. All parties involved benefit: the donor, the charity, and society at large. But, depending on the type of entity that receives the donation, the benefits to the parties may be different.
Everybody knows what is a public charity (think Red Cross, which is supported generally by the public with many donors) versus a foundation (think Bill and Linda Gates Foundation, which is supported predominately by one donor). However, in the last several years another charitable vehicle has gained some traction, namely a Donor Advised Fund (usually referred to as a “DAF”).
A DAF should be weighed against the other charitable vehicles for those who plan to include charitable giving in their tax or estate planning. So, what are the characteristics of a DAF? A DAF is a pre-established qualified public charity sponsoring organization, which allows for an earmarked account under its umbrella. Immediately upon transfer to the DAF by the donor, the charitable gift is complete and the donor receives the charitable deduction in that year. The donor, or their chosen successor person(s) such as a child, can advise as to what charities should receive support, and to what extent. But DAFs are not under the donor family’s control. In addition to the bigger deduction a donor can receive and the “plug and play” nature of donating to a pre-existing DAF, the beauty of a DAF is that a donor can later decide to which charity or charities it wants to donate, a decision that can change year-to-year.
Here are some key differences between DAFs and foundations.
- DAFs are not required to file a 990 tax return, while foundations are
- DAF donations have greater deductibility than a private foundation donation (60% of AGI vs. 30% of AGI)
- DAF donations receive deductibility based on fair market value at the time of the donation with a qualified appraisal
- A charitable remainder trust can name a DAF as the charitable beneficiary, whereas a private foundation would not qualify under the charitable remainder trust rules.
- Required minimum distributions (“RMD”) cannot be redirected to a DAF – without becoming a taxable distribution to the RMD recipient.
- Donors can keep his or her investment advisors in the DAF management, and likely the financial institution has a DAF already established for the donor to use.
One lesser discussed topic is the added layer of fees at the investment and financial institution level, which is a given at a DAF but something that may not exist at all at a foundation. While there may be certain legal and accounting requirements as well as corporate requirements that a foundation may count as a mandatory annual expense, a foundation does not need to pay a financial institution based off of the amount of money in its coffers. If a family plans to hold money for a number of years before it is all distributed to charitable organizations, these investment advisor fees could add up to be more expensive, particularly if the fund is growing.
Another potential drawback of a DAF is that there is no ability to employ or compensate friends or family so if the purpose is to bring family together or to teach the next generation about philanthropy, a DAF is not going to be the best tool.
A final significant consideration when weighing the best vehicle for a charitable donation is whether the donor is comfortable having no control over the assets gifted. If the gift is to a DAF, the investment advisors and sponsoring organization will have full control but for the limited advice the “advisor” provides in making charitable decisions on outbound money from the DAF.
While a DAF is an excellent option, it may not be the right option for every person who wants to make a charitable donation. Like everything else, there are benefits and drawbacks of directing gifts to a DAF. Our law firm, along with the other family advisors, guide our clients in making the best decision on charitable giving, including whether to create a family foundation, a charitable remainder trust, or simply make direct charitable donations to existing 501c3 organizations.
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