You know, just because we can’t all be Rockefellers, doesn’t mean we can’t leave lasting legacies. My clients who I’ll call Harry and Gabby, are an excellent case in point. This couple lives in Falmouth and has a terrific family. They’ve also made some very smart financial decisions over the years. Beyond the legacy they’ve planned to leave their family, Harry and Gabby are thinking about how their wealth can help support certain charities. To that end, they’re thinking about creating a Donor-Advised Fund, or DAF, an increasingly popular way for individuals to support the causes and charities they are interested in helping.
Wealthy folks have a long history of creating private foundations to help distribute their wealth to worthy causes. Names of large private foundations come to mind like the Bill & Melinda Gates Foundation, the Yawkey Foundation, and many others. The founders of such private foundations, and their heirs, maintain control over the foundations’ operations and the disbursement of their funds. But private foundations also have restrictions on how they operate that can make them less attractive to some philanthropists, and that’s where DAFs come into play.
A Donor Advised Fund is a separately identified fund or account comprising contributions made by either one or multiple donors. It is maintained and operated by a non-profit, section 501(c)(3) organization, referred to as a “sponsoring organization” that has legal control over the donations made. Although the donor (or donor’s representative) of any such fund relinquishes legal control over any contributions made, he or she retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. Contributions made to a DAF can result in a tax deduction for the donor in the year such a contribution is made and the funds within a DAF grow tax-free. Distributions are also tax-free provided they are made to a qualifying charity.
The establishment of DAFs has seen a strong uptick in recent years. Contributions to them are at an all-time high, according to the National Philanthropic Trust, totaling $23.27 billion at the end of 2016. The number of individual DAFs grew 6.9 percent in 2016 to 284,965. The average size of an individual DAF is estimated to be about $298,809 – though you don’t need nearly that much to set up a DAF.
Compared to private foundations, DAFs are less expensive to administer and easier to establish, they can provide some more substantial tax advantages, allow more flexibility in how funds can be used, and offer greater privacy to their benefactors.
So, let’s look at some of those benefits in greater detail.
One important thing to understand: You don’t need to be a billionaire like Bill Gates to create a lasting legacy using a DAF. Minimum account thresholds for setting up a DAF generally run from $5,000 – $25,000 depending upon the entity administering the account.
To create a DAF, a donor works with a sponsoring organization; a qualified 501(c)(3). Such organizations can include community foundations, faith-based institutions and even charitable arms of financial services firms such as Fidelity, Schwab, Vanguard, and others.
By law, donors to DAFs can only recommend how donated funds are distributed, both with respect to the recipient of any such funds and the timing of the disbursement (that’s what “Donor-Advised” means). But in almost all cases, sponsoring organizations will follow these recommendations – otherwise, contributions will dry up very fast.
While all sponsoring organizations impose administrative fees for operating a charitable account, they’re significantly less than the costs associated with setting up and managing a private foundation. Therefore, the barrier to creating and operating a DAF is much lower than with a private foundation.
Donors receive an immediate tax deduction whether making a contribution to a DAF or a private foundation. However, donations made to a private foundation are limited to 20% of Adjusted Gross Income (AGI) for gifts of securities and other appreciated assets, compared to 30% for such a donation to a DAF; and 30% of AGI for cash donations, compared to 60% for a cash contribution to a DAF. There is a five-year carry forward of any remaining deduction.
What’s more, all contributions to a DAF are valued at fair market value, whereas only contributions of publicly traded stock to a private foundation are valued at fair market. All other contributions to a private foundation are valued at the donor’s cost-basis, which can result in a lower tax deduction. DAFs are not subject to estate taxes.
As mentioned above, the donor to a DAF can also request the timing of a distribution to the final recipient. And unlike private foundations, that are required to distribute at least 5% of the net asset value annually, DAFs do not have a legally-imposed Annual Distribution Requirement (ADR). This is appealing to some donors who may want to make a tax-deductible donation in a particularly high income year, but who want to wait before making that donation available to a specific charity.
Finally, if maintaining privacy is important, there’s a significant benefit with DAFs compared to private foundations or other charitable-giving methods: DAFs allow a donor to make gifts anonymously. This is because the DAF (not the donor to the DAF) disburses the funds to the recipient charity. On the other hand, private foundations must file annual reports that disclose board members, recipients and other information that prevents them from remaining anonymous.
Philanthropy is important to Harry and Gabby because they benefited from charity early in their lives. It’s already been a significant part of their family life and a virtue they’ve instilled in their kids. It’s something they’d like to carry on after their passing too and most DAFs will allow the original donor to name successor fund advisors to carry on a legacy through future generations.
As with any form of charitable giving, there are a lot of considerations to make, so before setting up a DAF or any other charitable-giving vehicle, it’s vitally important for you to speak with financial specialist to understand how it will impact your financial future.
But DAFs and other charitable-giving vehicles can be smart and effective ways for families like Harry and Gabby’s to give back to the community and causes they find so vitally important to support while maximizing tax advantages to help protect their wealth.
Be vigilant and stay alert, because you – and the causes you believe in – deserve more.
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.
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