The Greater Pittsburgh area is often described as the city of giving as our community is filled with countless non-profit and charitable organizations. While this is surely a badge of honor worn proudly locally, the motivation to give back extends nationwide and leaves many pondering the most efficient ways to donate to their favorite charities. A vehicle that has gained significant traction (for good reason) over the past decade is a Donor Advised Fund (DAF).
Donor Advised Fund
A charitable investment account for the sole purpose of making future donations. Simplistically, an individual can contribute securities (stocks, bonds, mutual funds) or cash into a Donor Advised Fund and allow future growth to accumulate tax-free outside of an estate. The donor is then able to direct future contributions to their favorite IRS-qualified public charities.
Here is a step-by-step outline detailing exactly how a Donor Advised Fund works:
Step 1:
Accounts can be established with most U.S. based asset custodians with the help of your financial advisor. The application process is fairly streamlined and understanding that intentions or desired charities change over time, you do not even need to name a specific charity to direct donations.
Step 2:
Make an initial contribution to the Donor Advised Fund. Generally, these contributions come in the form of securities (stocks, bonds, mutual funds) or cash. However, often alternative assets such as restricted stock, partnership interest, life insurance, Bitcoin, etc. can also be accepted.
As contributions are made, those assets are then deemed to be outside of your estate and all future growth is non-taxable. Given this tax perk, donors should be strategic with their contributions. For example, if an investor purchased a stock many years ago and now has a sizable unrealized tax gain within that position, they could transfer the stock holding into the Donor Advised Fund (claim a tax deduction) and essentially shift that investment gain outside of their estate.
Step 3:
Establish a suitable investment portfolio within the Donor Advised Fund. Remember, all investment growth within this type of account is tax-free. Therefore, the donor can liquidate appreciated investments (without realizing the tax gain) and re-invest within a more balanced portfolio. We recommend working with a financial advisor to determine an investment strategy that is aligned with both your risk tolerance and time frame.
Step 4:
Claim the tax deduction. Upon making any contribution to a Donor Advised Fund, you become eligible for immediate tax deduction, just as you would with donating directly to a charity.
As a general rule, the IRS typically allows income tax deductions up to 60% of your adjusted gross income for “cash” donations and up to 30% of your adjusted gross income for appreciated securities (stocks, bonds, mutual funds) donations.
Step 5:
Distribute accumulated funds to your favorite charities. Unlike other charitable giving accounts, most Donor Advised Funds do not have annual distribution requirements. Working with the custodian/sponsoring organization, the donor has the discretion to make donation withdrawals over time and to numerous IRS-qualified public charities.
Naturally, we all want our charitable donations to be as beneficial as possible. Given the flexibility and general simplicity, it’s easy to see why Donor Advised Funds are the fastest-growing charitable donation vehicle currently in the United States. If you are charitably-inclined and this strategy is of interest to you, please reach out to your financial advisor at Fragasso, or reach out to me directly if you are not yet a client.
