Donor-advised funds can help you reduce your tax bill while giving to charities you favor

• A donor-advised fund is an investment account that offers potential growth for your charitable contributions.
• If you itemize your tax returns, you can also deduct up to 60% of your contributions to a donor-advised fund.
• Donors have a say in which charities the funds contribute to, although not the final word.
• Read more stories from Personal Finance Insider.

A donor-advised fund, or DAF, is an investing account that allows you to contribute to it and receive immediate tax benefits, but donate to charity over time. You may be able to receive an itemized tax deduction from your donations, as well. 

How donor-advised funds work 

The purpose of a DAF is to allow philanthropic donors to boost the amount of money they give by growing their funds, as well as receiving tax breaks. These accounts have been increasing in popularity. The number of individual DAF accounts reached 1 million in 2020, according to the National Philanthropic Trust.

One reason for the recent rise in the number of DAFs is a change in the federal income tax law made in 2017. It increased the standard deduction, which for the 2021 tax year is $12,550 for single filers, $18,800 for heads of households, and $25,100 for filers who are married and filing jointly. For donors who itemize their taxes, it would make more sense to take the standard deduction if their itemized deductions (including charitable donations) amount to less than that.

However, the donor-advised fund offers a workaround. You can contribute multiple years’ worth of donations at one time to a donor-advised fund. This is known as “bundling” charitable contributions. The tactic allows you to receive the tax perks but continue to grant donations over multiple years. “The donor-advised fund made sense before, but now it makes even more sense,” says Alfredo La Rosa, executive vice president of Intercontinental Wealth Advisors. 

Any individual donor can allocate assets to a DAF. “Anyone can give money away,” says La Rosa. However, La Rosa points out that, for many people, it’s not going to make sense to contribute to a DAF because there are no tax advantages to doing so. So if you plan to donate less than the standard deduction amount, you can simply donate directly to the charity.

Donor-advised fund contributions can come in many forms — from cash to bonds to real estate to stocks. These funds are managed by what is known as a sponsoring organization. Many of these sponsoring organizations are charitable subdivisions of well-known financial firms, like Fidelity, Charles Schwab, or Vanguard. If you have a large balance, you can choose to have an investment advisor manage the account for you.

Unlike many regular funds, DAFs may not require a minimum donation amount each year. “The money is ultimately invested in mutual funds, which are the same as your regular mutual funds,” says La Rosa. 

As soon as funds are added to a DAF, the sponsoring organization obtains legal control over the money. However, the donor is allowed to advise where the money should be invested — donors can choose among the qualifying investment options. Also, donors can help decide which charities should receive the donations, known as grants, and when the grants go out.

What are the benefits of a donor-advised fund? 

Using a donor-advised fund rather than contributing directly to charity is more popular than ever, and there are several advantages to them.

Tax deductions

Itemized deductions reduce the amount of your income that can be taxed, thus saving you money on your tax bill. When you itemize your taxes, you can typically deduct between 20% and 60% of your adjusted gross income for charitable contributions (depending on the type of asset and the kind of charity). 

Donor-advised funds allow donors to contribute multiple years’ worth of donations at once. This feature offers a path to receiving tax benefits for donors whose annual itemized deductions wouldn’t amount to more than the standard deduction.

Receiving a tax benefit can also help donors maximize their gift. For example, if you have $100 to donate but you have to pay taxes, you’ll only have $70 you can give to charity. 

The tax benefits with a donor-advised fund are also immediate — you take the deductions in the same year as your contribution to the donor-advised fund. Thus, you can donate to charity over several years by allocating grants from the DAF but receive the tax break right away. 

Ability to grow charitable contributions

A DAF also can increase the amount you have to donate to charity. Like any investment, the money can grow while it sits in the fund. You choose among the available investment options, and “most of them offer a wide range of risk levels and strategies,” says La Rosa. Plus, you can continue to make donations in your name even after you die.

Reduced capital gains tax and estate tax

By using a donor-advised fund, you’ll avoid paying capital gains tax on the assets you allocate toward it. Plus, your deductions might increase: if you bought an asset for less than it’s worth today, you can deduct its current market value instead of the original price.

Also, if you owe estate taxes, you won’t need to pay them on any assets you put into a DAF. 

Ability to be anonymous

Some donors prefer to remain unidentified because they would prefer to keep their donations private. A DAF allows any donor to choose for their gift to be granted anonymously.

How to get started in a donor-advised fund 

Investing in a donor-advised fund requires a bit of research before diving in. Here are the steps to follow when considering a donor-advised fund.

Step 1. Research your options and choose a fund

Look into the details of several sponsoring organizations to decide which will work best for you. You’ll want to research factors like the minimum opening contribution, the minimum for further contributions, the annual fees, and the minimum amount for a grant. 

Step 2. Add assets to the donor-advised fund

Next, it’s time to allocate assets to the fund. You can contribute cash by using a wire transfer or check, or transfer appreciated assets to the fund. Additionally, you can consolidate other donor-advised funds into a single fund.

Step 3. Choose the investments to help your money grow

Donor-advised funds have a pre-set list of investment options, and you have to look at each one to decide which is best for you. There’s no mandatory date to distribute the funds, so they can build over time.

You can also help to allocate funds to a DAF one year to get the immediate tax benefits, but then give yourself time to research the best charity for your money.

Step 4. Select your charities

You can grant your DAF funds to most charities that are registered under Internal Revenue Services Code Section 509(a) and are tax-exempt under Section 501(c)(3). Specific private operating foundations may be able to accept funds from a DAF as well.

Step 5. Consider itemizing your taxes

For those who donated more than the standard deduction, itemizing your taxes can make your money go further. If your itemized deductions are greater than the standard deduction, fill out a Schedule A form. 

Potential drawbacks of donor-advised funds 

Donor-advised funds aren’t without flaws. In recent years, they’ve received criticism because some organizations appear to have abused them. This led the IRS to create new requirements in an attempt to stop it.

There are also a few potential downsides to consider before getting involved in a donor-advised fund.

First, “there’s always a cost,” says La Rosa, explaining that there are fees like with any investment fund. The administrative fee is usually 0.6%, but each has its own specifications and schedules. Also, consider any maintenance or investment fees.

Additionally, you have to be willing to give up control. Although donors have advisory privileges, the sponsoring organization has the final say in how the funds are granted. You must also plan in advance to get the most bang for your buck. You may need to put enough in your DAF to cover several years’ worth of donations to receive tax benefits, and this might be out of reach for some donors. 

This fact is especially true because these assets are irrevocable, meaning you can’t get them back. “Once you submit the money to a donor-advised fund, it’s gone,” says La Rosa. “It’s no longer yours.”