Charitable giving is an increasingly important part of wealth management, both to allow donors to support causes they believe in and provide them with helpful tax relief. That might be why more than half (56%) of surveyed Americans donated to charity in 2021 and why charitable giving remained popular among high-net-worth individuals even during turbulent times like the 2020 COVID-19 pandemic.
Donor-advised funds (DAFs) are increasingly the go-to charitable vehicle for both individual and family giving. Part of what makes DAFs so popular is that a donor can be eligible for a tax deduction during the same calendar year they establish a DAF while still being allowed to make disbursements through the following year and beyond.
With the start of 2023, here’s what advisors should be communicating with their clients about DAFs tax benefits and how they can influence wealth management decisions.
How to communicate the benefits of a donor-advised fund to clients
DAFs are the fastest-growing charitable giving vehicle for several reasons, but this is largely due to the freedom afforded to donors to make charitable donations and receive immediate tax benefits. With a DAF:
- Donors can receive an immediate income tax deduction for their contribution, with up to 60% deduction of AGI for cash donations and up to 30% of AGI for securities and other appreciated assets (i.e. closely held stock, real estate, illiquid assets).
- There is no capital gains tax on gifts of appreciated assets and no estate taxes.
- Investments will appreciate tax-free, creating additional funds for future donations.
- Any donor that is subject to the alternative minimum tax (AMT) can have their AMT impact reduced by their contribution.
Beyond the DAFs tax deductions, the major benefits of DAFs center around their flexibility, their simplicity, the ability to maximize deductions, and how they can be transferred to other family members.
- Flexibility. While clients will receive an immediate tax benefit at the time they contribute to their donor-advised fund, they don’t have to immediately decide on how the gifts are disbursed. Donor-advised funds allow clients the freedom to transfer a mix of cash, securities, and other assets to the fund tax-free and then distribute gifts to nonprofits they can select over time. This allows donors the flexibility to recommend grant distributions to one or more charitable organizations on their own personal timetables, from years to decades.
- Simplicity. Compared to other charitable vehicles, such as private foundations, donor-advised funds are simple to operate and carry fewer expenses. Any required minimum contribution to a donor-advised fund will often be much lower than that of a private foundation, and the DAF will not require the same legal fees or additional costs. There are also fewer responsibilities for the donor; while a private foundation might require a donor to participate in board meetings and file tax returns, with a donor-advised fund, it is the sponsoring charity that handles all administration duties and investment management.
- Deductibility. The simplicity and flexibility of donor-advised funds mean they work well as part of a bunching strategy to maximize a donor’s tax deductions over a period of a few years. Bunching is a helpful option for clients whose yearly donations don’t exceed the standard deduction. Instead of donating the same amount every year, the donor can skip one or two years and then donate that “bunched” full amount to the donor-advised fund. In that year, the donor will exceed the standard deduction and so can itemize all of the deductions when filing their taxes to claim greater tax returns then they would have received normally.
- Transferability. Donor-advised funds make it easier for donors to establish a line of wealth with their family members and heirs. Clients have the option to support multiple charities through a bequest in their wills to the donor-advised fund sponsor, which can reduce the burden of estate tax for their heirs. Those same heirs can even be named successor grant advisors to take over the donor-advised fund after your client’s passing, allowing the family to support important causes for generations to come.
To that last point, baby boomers are currently the largest generational demographic that donates to charity. At 51 million donors, they contribute 43% of all charitable donations. However, much of their accumulated wealth is set to pass on to their children, and the upcoming generations are no stranger to giving. It’s reported that 74% of millennials and 66% of Gen Zers donate to charity or provide monetary assistance to others. Those upcoming generations are set to be future clients, so it’s important to be the first to talk to them about how to support their charitable giving and ensure that they’re not going to other firms or advisors.
What to be aware of when establishing a donor-advised fund
While DAFs require less of donors than other charitable vehicles, there are still some important general guidelines that must be followed. The major DAF guidelines are:
- All contributions are irrevocable and cannot be taken back once they are gifted.
- While donors maintain advisory and grantmaking privileges, all donated assets belong to the sponsoring organization.
- Neither donors nor their family members can receive any personal benefits from donor-advised fund grantmaking, either directly or indirectly.
- While there are no contribution limits on how much a donor can contribute to a DAF, some sponsors may require a minimum contribution and/or a minimum grant amount.
- All grant recommendations from DAFs must be approved by the sponsoring organization. A donor’s grant recommendation could be rejected if it doesn’t abide by the organization’s standards or guidelines.
- No grants to individuals are allowed. Grants must go to a qualified public charity, recognized by the IRS. DAFs may fund scholarship opportunities based on a defined set of student criteria.
There can be specific requirements and limits from year to year, though currently there are no changes from 2022 to 2023. There are also other options available in how they utilize their DAF. For example, if a client wants to create an income stream for themselves or their family, they can consider funding a charitable remainder trust through a DAF.
Donor-advised fund tax deductions are lifelong benefits
Tax reporting can be a burden for institutions, advisors, and donors alike — especially at the end of the year when clients realize they need to make a charitable deduction. Instead of making a rushed decision, proactively working with clients to find out if a DAF can enable them to maximize their tax benefits while more effectively supporting causes that they truly believe in.
Start by taking the client’s tax situation, charitable goals, and how they want to support their family into consideration. If clients have any expected large taxable event in the future, they may prefer to set up their DAF for that coming year. Making their charitable giving a key part of their investment and their overall tax savings is important for optimizing their financial planning for their lifetime, rather than just the current year.
If you’re interested in more information on how a DAF can be administered, or would like to explore a variety of giving needs, be sure to talk to our experts at Ren.