How Donor Advised Funds Work
We are getting into the fourth quarter of 2021. There is pending tax legislation on the horizon and year-end tax planning moves are on people’s minds right now. For those who are charitably inclined, donor advised funds can offer significant tax planning advantages now while setting up the structure and foundation for your long-term charitable gifting into the future. Donor advised funds are charitable gifting accounts that are set up, funded and administered by individuals or their families to be used as the primary vehicle for their long-term annual gifting.
An individual or family can set up a donor advised fund at any qualified custodian or organization. You can give your fund a name to personalize it. This account is then funded with an immediate irrevocable lump sum contribution of assets such as cash, stock or real estate. The money is held in the donor advised fund to be used for future charitable gifting. At the time of contribution, the individual will receive an immediate income tax deduction for the full fair market value of what was put into the donor advised fund. Once the money is in the account, that individual can control the amounts and the timing of their overall contributions to charitable organizations both now and into the future.
Ideally, the accounts are set up and funded with a large lump contribution of assets so the donor receives a meaningful income tax deduction. Once the assets are in the account they will be invested and have the opportunity to grow over time while also being available to make gifts, as needed, consistent with your overall charitable gifting cadence. The donor advised fund allows you to combine some of the tax planning benefits of controlling your annual charitable contribution when you fund the account, and then you can give money on your own timeline.
Advantages of Donor Advised Funds
I would like to highlight a few other important advantages of a donor advised fund. When the account is set up and initially funded, you could contribute cash and receive an income tax deduction up to that amount. You can also use appreciated securities, such as stock, that you have owned for a while and have significant gains. When you put appreciated stock in the donor advised fund, you will avoid any of the unrealized capital gains embedded in those positions.
Let’s say you have $50,000 worth of stock that has a cost basis of $25,000. You can move that $50,000 in shares from your portfolio into the donor advised fund and you will escape $25,000 of unrealized capital gains. There are significant tax savings by just sliding certain assets into the donor advised fund. Additionally, once money is in the account it can be reinvested. That money can then grow tax-free, allowing you to give even more to charities in the future. You have the opportunity to further grow the funds in the account and not pay any income tax on the growth.
Donor Advised Funds Help You Pre-Fund Charitable Contributions
Say you are an individual or family who gives $10,000 a year to various charitable causes and organizations. Under the current tax laws (given some of the limitations on itemized deductions), you might not be getting the full income tax deduction benefit of these annual $10,000 charitable contributions. What you might do instead is set up a donor advised fund and fund it with a large lump sum contribution, let’s say $100,000. You are essentially pre-funding your next 10 years’ worth of charitable contributions. At the time of funding, you are going to receive a $100,000 charitable deduction on your tax return, significantly offsetting your current year income. If you have an investment portfolio that holds appreciated securities, you could slide $100,000 of those securities that have a $50,000 cost basis into the donor advised fund and you will avoid $50,000 of gains on that position just by contributing those securities to the donor advised fund.
Once that money is in the account, you can continue to make your annual $10,000 charitable contributions, but now you do so from the structure of your donor advised fund, as opposed to just writing checks each year or using cash. You really have not changed anything with respect to your overall charitable gifting strategy, but you are taking advantage of some of the tax benefits around the structure of a donor advised fund by receiving a potentially large income tax deduction, using appreciated securities to avoid capital gains, gaining tax-free growth within the donor advised fund and keeping the flexibility to give money on your own timeline into the future.
One other important advantage of a donor advised fund is that when you set it up and fund it, you are not limited to funding it in just the year you establish the donor advised fund. You could put money into it however often you want, up to any amount you want. Let’s say five years from now you have a high-income year where you are going to find yourself in a high-income tax bracket. You can once again take another large lump sum and make a contribution into the donor advised fund. You will get a large income tax deduction offsetting that earned income. You can use appreciated securities, and all you have done is replenish your donor advised fund and effectively pre-fund years and years’ worth of future charitable contributions.
Simply put, a donor advised fund can be a smarter way of gifting for a lot of people that adds significant tax advantage while allowing you to control how much and when you want to give to charitable organizations. A lot of people assume that charitable accounts and other types of non-traditional gifting strategies are reserved only for the ultra-affluent. That is absolutely not the case. I believe donor advised funds make sense for a lot of people – they are simple, easy to use, easy to administer, easy to manage – and they can really add a lot of value to your long-term charitable gifting strategy.
An Experienced Advisor Can Help
This is a nuanced strategy, and you may want a professional to guide you through it. At Creative Planning, we help our clients develop custom strategies to achieve their long-term goals. As a nationally recognized wealth management firm, we deliver a team of credentialed, educated, experienced and action-oriented advisors, including CERTIFIED FINANCIAL PLANNER™ practitioners, certified public accountants, insurance specialists, attorneys and other professionals dedicated to helping you achieve your goals. We work together to help ensure all aspects of your financial life are well cared for.
If you’d like help developing your charitable gifting strategy, or any other financial matter, please schedule a meeting with us today.