How donor-advised funds work
A donor-advised fund offers a middle ground between participating in simple “checkbook charity” and starting a nonprofit foundation.
Often considered smaller and nimbler cousins of private foundations, donor-advised funds offer many of the benefits of foundations, including the ability to:
- Involve multiple members of the family, friends, or other advisors
- Research potential recipients
- Recommend how funds are distributed
But, unlike foundations, donor-advised funds require less legal and financial paperwork, such as an annual tax filing that is subject to public inspection, regulatory requirements, and excise taxes.
How do you contribute?
Donor-advised funds allow you to contribute cash, stock, real estate, or other assets, such as business interests. These contributions can be bunched to combine multiple calendar years’ worth of gifts into one year, which may offer tax benefits if you are close to your standard deduction limit.
You may partner with a donor-advised fund sponsor or the sponsor may run your fund. A fund sponsor can be a financial institution or a community, educational, or religious institution. Grants may then be recommended by you or your designee to your charities of choice.
Rather than keeping track of gift receipts from multiple charities, a donor-advised fund serves as your single source for tax receipts and grant recipient information.
Generational shifts mean big changes
“A few years ago, donor-advised fund contributions were typically less than $250,000,” says Beth Renner, Head of the Advice Center within Wells Fargo Wealth and Investment Management. “Now they sometimes can be millions of dollars, driven by sales of family businesses and capital gains windfalls.
“We’re also starting to see generational differences around how families want to engage with philanthropy,” she says.
“The [younger] generations are saying, ‘I don’t want that administrative burden that goes along with a foundation. I want to engage in the fun part of giving.’” No board meetings and much less paperwork for donors allow more time to focus on the engaging parts of philanthropy, like meeting grantees and focusing on impact.
“We’re seeing many families use donor-advised funds to introduce their children to philanthropy and teaching them financial literacy along the way,” says Arne Boudewyn, Head of Family Dynamics Consulting for Wells Fargo Wealth and Investment Management.
More potential considerations for donors and recipients
Donor-advised funds are gaining popularity for other reasons as well, including:Anonymity
. When you give gifts to a charity through a private foundation, those gifts become public record through IRS form 990-PF. In contrast, you can choose to make your gifts from a donor-advised fund be anonymous.Recurring gifts
. Many donor-advised funds have recurring gift options so you can optimize your giving in line with your giving strategy and the organization’s needs. If you had previously used credit cards to make recurring gifts, you can use tax-advantaged dollars and save a charity from costly credit card processing fees. Noncash gifts
. Appreciated stock, real estate, or collectibles are easier to handle for the giver and the recipient through a donor-advised fund. This holds true even for highly liquid yet noncash assets like cryptocurrency.
“Boomers can be collectors,” Renner says. “Their son or daughter often doesn’t have the same level of affinity for Dad’s 1950s car collection. So some parents are choosing to donate these assets into donor-advised funds.”
While many charities may be unable to take noncash gifts given the level of complexity, donor-advised funds serve an important role to help charities benefit from the wealth accumulated in these illiquid assets.
Of course there are some potential downsides about which anyone considering a donor-advised fund should be aware:Irrevocable donations
: The donor to the fund cannot withdraw their money for any reason once it’s gifted.No legal requirement to make grants
: There is no legal requirement to grant the money donated to the fund. Recently, this has been viewed as a criticism of donor-advised funds as grants are not being made to worthy causes when needed.Underlying costs/fees
: Be aware of the administrative fees associated with the management of the donations as well as the investment options within the fund.Grant making restrictions
: Grants can only be made to certain eligible 501(c)(3) organizations that the IRS recognizes as public charities. These organizations cannot accept goods and services, such as tickets to a gala, or to satisfy personal pledges.
Potential tax advantages
“Many of the people we see using donor-advised funds will have a significant liquidity event of some kind such as the sale of real estate or a business,” says Matt Lawson, Senior Philanthropic Specialist, Wells Fargo Bank. “They could use the tax deduction right now, but they don’t want to give 100% of the value to their favorite charity immediately but rather over a period of time.”
- You may receive a tax deduction subject to your Adjusted Gross Income (AGI) limitations.
- There is no capital gains tax for highly appreciated assets when sold inside the donor advised fund. The invested assets have the potential to grow tax-free, which could increase the eventual grant that you can make from the fund at a later date.
- Real estate gifts are valued at their current value, which can potentially provide a bigger tax break if the property has appreciated, unlike similar donations to a private foundation that limit the deduction to the cost basis in the property.
If you’re considering using a donor-advised fund but are uncertain about whether it could be right for you, a professional financial advisor may help you decide.
Our firm is not a tax or legal advisor.
Wells Fargo Wealth and Investment Management (WIM) is a division within Wells Fargo & Company. WIM provides financial products and services through various bank and brokerage affiliates of Wells Fargo & Company.
Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.
This article was written by/for Wells Fargo Advisors and provided courtesy of Brian Konish, Managing Director-Investments in Boston at 617-289-9418.