Find out more about what DAFs are, how they work, and some of their pros and cons.
Definition and Example of Donor-Advised Funds
A DAF is a type of charitable investment account that allows investors to support charitable organizations that are important to them. You can contribute cash, securities, or other types of assets to a DAF. Typically, you can receive an immediate tax deduction after contributing to a DAF, and the funds invested gain tax-free growth potential. With a DAF, you can recommend grants to most IRS-qualified public charities, allowing you to choose where your donation goes. With a DAF, you don’t have to identify a nonprofit beneficiary as soon as you make a contribution. You can wait to decide to which eligible nonprofits you want to grant funds, letting the investment potentially grow in value.
How Donor-Advised Funds Work
DAFs are typically separate funds or accounts operated and maintained by a Section 501(c)(3) nonprofit organization that is the DAF’s sponsoring organization. All DAF accounts are made up of contributions from individual donors. After the donor makes a contribution, the sponsoring organization has legal control over the contribution. Even so, the donor or their representative still maintains certain advisory privileges when it comes to the distribution of funds and the investment of account assets. Generally, if you want to set one up, the process of investing in a DAF looks like this: Step 1. Make a tax-deductible donation: You can contribute cash, stocks, bonds, and non-publicly traded assets (such as private business interests, cryptocurrency, and private company stock), among other assets, to a DAF and likely will be eligible to receive an immediate tax deduction when you do. Once you donate these funds, they can’t be returned or used for any other purpose, as this is an irrevocable commitment. Step 2. Grow your donation: Even if you don’t choose charities to support right away, your investment can grow tax-free, which can increase your charitable contribution over time. Typically, sponsoring organizations have a variety of investment options from which to choose, so you can pick an investment strategy for your donation when you’re ready. Step 3. Choose a charity to support: If you didn’t do so at the time of your contribution, you can choose an IRS-qualified public charity to support. The charity that sponsors your DAF is in charge of conducting due diligence to make sure that the funds you grant to a specific charity are used for charitable purposes.
Pros Explained
Can donate a wide range of assets: You can contribute non-cash assets to a DAF, such as stocks from a brokerage account.You gain immediate tax benefits: Upon making a contribution to a DAF, you should be eligible for a tax deduction right away.Contributions can grow tax-free: Your contributions are invested and potentially can grow in value without being taxed.Streamlined recordkeeping: When you contribute to a DAF, you don’t need to keep track of all charitable gifts you make; you can simply use the receipts from your donor-advised fund contributions.
Cons Explained
Limitations on donation recipients: Rules governing DAFs prohibit supporting some organizations or beneficiaries, such as political groups, crowdfunding campaigns, or something that may provide a personal benefit, such as tuition for a grandchild or charity-event tickets for yourself. Contributions are irreversible: Once you donate these funds, they can’t be returned or used for any other purpose, as this is an irrevocable commitment.
Private Foundation vs. Donor-Advised Funds
It’s easy to confuse private foundations and DAFs, as both are charitable-giving vehicles designed to help donors arrange and meet their giving goals. However, private foundations are separate legal entities, unlike donor-advised funds. Private foundations are established by individuals, families, or businesses. The IRS sets strict rules and regulations for private foundations, but one benefit that comes with them is that their donors have more administrative control over assets and types of grantmaking.
