Donor Advised-Funds | How Do Donor-Advised Funds Work?
One of the distinct characteristics of the Millennial generation is that we’re incredibly social-impact conscious.
But that theme is probably not surprising.
It might be more surprising to learn the IRS has created and authorized tax-deductible financial giving accounts. They’ve been around a long time, but not many people know about them—especially millennials.
These are accounts that are checking/investment accounts but specifically for charitable giving. They are called “donor-advised funds” (DAFs), and Millennials are largely not using them today. Boomers are dominating their use; the average age of a DAF holder in the US is 55.
But even among Boomers, they aren’t that well known. Less than 1% of US households who give to charity have a DAF at all.
More people should know about them. My aim here is to explain how DAFs work and mention a couple of ways they can be used to save money on your taxes and enrich your life.
In This Article:
What Are Donor-Advised Funds?
Donor-advised funds are tax-deductible financial accounts provided by 501c3 nonprofits who are approved, donor-advised fund sponsors.
The funds are opened in the donor’s name, and they enable a donor to donate funds and get a tax-deduction immediately while deciding later which organization those funds will support.
Some donor-advised funds allow donors to invest the funds while they are in the account, and earnings can be given away tax-free. The nonprofit organization legally owns the funds in the accounts but allows donors to “advise” on the investment and destination of the funds.
How Do Donor-Advised Funds Work?
Here’s the 411 on how Donor Advised Fund’s (DAFs) work, after you set up a DAF, you can add money or appreciated assets into one of these funds and get the full tax deduction for the money or assets on the day you put them in the fund.
And then, any time in the future—whether one day or ten years later—you can give the money out to any charity of your choosing. Most organizations that offer these funds have some form of web portal for you to create and manage them.
Historically, DAFs were created by the IRS to help ultra-rich folks who may sell an asset—or a bunch of assets—and realize a high amount of taxable gains in a single year. DAFs enabled them to immediately offload capital to charity, offsetting big capital gains without having to pick a specific charity. This is particularly helpful if a person sells a company or property and doesn’t have a charity ready to receive such a large sum of money.
Have that problem? Me neither. The DAF’s legacy of existing for very wealthy folks has pretty much continued, and that is why not many of us have heard of them. They are offered mostly by community foundations or large asset managers like Fidelity, Schwab, and Vanguard. There are significant fees and plenty of financial jargon to navigate, particularly related to investing charitable assets, which is now the key reason why they’ve remained a tool for the 1%.
On the flip side, as a philanthropic consultant in a previous life, I watched a bunch of our major donor clients use DAFs, and I saw how it created some simplicity.
If you disregard the fees and jargon for a moment, DAFs create a couple of nice capabilities for donors:
- One tax receipt for all giving. support any charity from one place
- Give to charity today, and select which specific organization tomorrow
- Track all your giving over time
- Don’t have to expose your financial information to any nonprofits
- Send anonymous gifts when appropriate
What Is The Benefit of a Donor-Advised Fund?
There are some standard benefits of donor-advised funds.
- Tax deduction now, charitable organization decision later. A donor may contribute funds into their donor-advised fund and receive a tax deduction immediately. Then, they can decide, at any point in the future, which organization to support with that money. There is no time restriction on when that money must be sent to a charity. It enables donors the ability to make a fully-informed, careful decision about the organizations they want to support.
- Give anonymously. Donor-advised funds make it easy to support organizations anonymously, either for the purity of not receiving “credit” for the gift, or to avoid getting on mailing lists.
- Appreciated assets. Donor-advised funds are often better equipped than charities to receive appreciated assets like stocks and ETFs. Some are equipped to receive complex assets like private company shares and real estate.
But let’s talk about some more specific benefits in detail:
1. DAFs Can Help You Potentially Save Thousands
The Tax Cuts and Jobs Act (TCJA) increased the standard deduction on federal taxes for 2018. It’s been that way since. For single filers or married filing separately, it was raised to $12k, and for married filing jointly, $24k.
For a lot of middle-class folks, this means it’s tough for giving to be tax deductible anymore. Unless the total of all of your giving, mortgage interest, and property taxes (potentially plus other things) is higher than these increased standard deductions, you won’t see any tax-deductibility on giving since you’ll take the standard deduction instead of itemizing.
For Example: A married couple—let’s call them “the Smiths”—gives $8k per year to charity and has mortgage interest and property taxes of $12k in the tax year. They would take the standard deduction of $24k because it’s greater than their itemized deduction of $20k ($8k + $12k).
But! In this example, the Smiths have an opportunity to save a lot of money on their taxes via their charitable giving even though they don’t clear the standard deduction.
The concept is called “bunching” giving.
Bunching is when you give out two years of charitable giving in one tax year, and then give nothing the next tax year. It allows you to itemize every other year and take the standard deduction in the “off-years.” It’s worth a ton of money.
In other words, over a two-year period, you’d want to give out all your charitable giving and other deductions in year 1 “bunch all your deductions,” and then have as few as possible in year 2 when you take the standard deduction. You can potentially pre-pay taxes or personal business expenses in year 1 in addition to bunching your giving.
Let’s look at how this plays out for our above-married couple, the Smiths.
Instead of giving $8k per year, the Smiths could give $16k in year 1, and $0 in year 2. Let’s see what happens to their tax obligation.
Since they gave $16k, and they have $12k in mortgage interest and property taxes, they itemize in year 1 with total deductions of $28k. Then, in year 2, they take the standard deduction of $24k.
Over the two-year period, by bunching, their total deductions are $52k instead of $48k. At a ~20% effective tax rate, that extra $4k is worth ~$800 in savings. That’s the equivalent of a tax-free 10% return on sending that extra $8k to charity a year early.
Here are a couple of tables below to explain further what bunching looks like for the Smiths.
|Year 1||Year 2||Total|
|Mortgage & property tax||$12k||$12k||$24k|
|Total deductions taken (minimum $24k standard deduction)||$24k||$24k||$48k|
|Year 1||Year 2||Total|
|Mortgage & property tax||$12k||$12k||$24k|
|Total deductions taken (minimum $24k standard deduction)||$28k||$24k||$52k|
Now, you may think, “it’d be tough to just forsake giving to charity for a year.” I agree! That’s where the DAF comes in.
If the Smiths put their bunched $16k of giving into a DAFin year 1, then they can grant it out slowly from their DAF to their charities over the two-year period. Their favorite charities never see a change in their support.
Charityvest supports this behavior, as do many of the other donor-advised fund sponsors.
A lot of people are starting to bunch, and the savings are significant. The more significant your giving or mortgage/property tax obligations, the larger the bunching effect can be.
For example, if the Smiths gave $15k per year, bunching would increase their total tax deductions over a two-year period by $12k, which is worth (assuming ~20% effective tax rate) ~$2,400 in tax savings to them.
You may be thinking, “Well, I don’t own a big home or give a lot to charity. This is well and good for folks who can, but I’m not there.” You can actually bunch across as 3 or 4 tax years if savings allow and still see a healthy financial benefit.
It’s a great strategy that can save many households thousands.
2. DAFs Open The Door For a Happiness Life Hack
There’s an amazing amount of research behind the fact that giving creates happiness. A simple Google search of “Giving happiness research” is nearly overwhelming.
If you want to be happy, an empirically proven way is to give to others. Winston Churchill is credited with saying, “We make a living by what we get, but we make a life by what we give.”
Diving into the giving research, what’s interesting is that more giving creates more happiness. The effect doesn’t diminish. University of Chicago psychologist Ed O’Brien says,
“Repeated giving, even in identical ways to identical others, may continue to feel relatively fresh and relatively pleasurable the more that we do it.”
And DAFs provide a simple way to get going on giving without introducing a ton of complexity. They enable a user to commit as much as they’d like to charity without necessarily having to make the complicated and personal decisions about who to support at that point.
They also make budgeting for giving simple, as you just put all the money you want to give over into a single account and distribute it to charities from there when you’re ready.
DAFs are a simple way to get activated in intentional generosity.
Behavioral economics has shown that commitment devices in behaviors that are “good for you” are really helpful. A commitment device is one decision you can make upfront that locks you into future behaviors that further your goals.
For example, Cortez burning the ships when invading Mexico is an example of a commitment device for his invasion campaign. With DAFs, you can set up recurring contributions and grants easily to commit yourself to give and see some happiness benefits.
A New Kind of DAF For The Tech Era
After seeing them in action, I wanted a DAF. But I knew my giving was not at such a level to warrant all that complexity. I just wanted a way to more simply manage my giving: from one place, quickly, and avoiding all the pain of traditional online giving pages—fees, entering financial data, mailing lists, etc.
So, with that in mind, some friends and I created Charityvest, which is a simple DAF to provide you your own personal charitable giving fund—free. 100% of the money goes to nonprofits.
Effectively it’s a “Venmo for Charitable Giving.” An app to run all your giving through with no fees or complexity. It’s a DAF designed for everyone—including millennials.
We don’t charge anything for the opening or use of the giving funds, which is why I feel comfortable writing about it here. This is a social enterprise to get everyone in the US their own giving fund and help them think more like philanthropists. It’s about spreading the benefits of intentional philanthropy.
Donor-Advised Funds FAQs
We hear these questions regularly, so we are here to help:
Are Donor-Advised Funds a Good Idea?
Donor-advised funds are a good option for a broad base of donors, and with innovations in the space, they are becoming an attractive mode of giving for nearly everyone.
The reasons you wouldn’t want to give through a donor-advised fund are:
- Fees (if that donor-advised fund has them)
- The complexity of the donor-advised product
- If the organization you’d like to support specifically prefers another mode of giving
For most people and the vast majority of organizations, donor-advised funds are a great option for giving.
Are Contributions to a Donor-Advised Fund Tax Deductible?
Contributions to donor-advised funds must be tax-deductible, and funds may only be granted out funds to tax-deductible organizations.
So, Is a Donor-Advised Fund for You?
Giving is good, and a DAF opens up a lot of flexibility in your giving without any of the complexity.
At Charityvest, we talk about helping people write a richer story about their lives. I don’t know about you, but I don’t want to be known for how much money I made or how hard I worked. A DAF can be the “pen” to intentionally take steps toward writing that richer, deeper story of your life.
And now that you know, you can save a bunch of money on your taxes while being more intentional about the story you want to write with your life.