Donor Advised Funds – An Efficient Tool For Charitable Giving

83% of Americans give annually to charity. Charitable giving is clearly an integral part of the culture of successful families in this country. While Americans are generous with their giving, they are often giving inefficiently from a tax perspective. Families could be saving significant dollars by donating securities or assets with long-term appreciation to charity or to a donor advised fund (DAF) instead of contributing cash directly to charities (which is more typical). Donor advised funds have been the fastest growing philanthropic vehicle in the nation over the past few years, yet a recent survey by Fidelity Investments found that 70% of investors had never heard of them. Donor advised funds offer wealthy and middle-class families many of the benefits of having a charitable private family foundation without the costs, administrative hassles, and high minimum asset levels that typically go with them. Many very wealthy families are choosing to use donor advised funds rather than setting up a private family foundation due to the dramatically lower costs and administrative headaches. Some wealthy families are even shutting down their private foundations and moving that money into a donor advised fund program. Private foundations are often uneconomical in sizes of under $3-$4 million. Donor advised funds are a simple, affordable, and flexible charitable-giving tool.

What are Donor Advised Funds and how do they work?

A donor advised fund (DAF) is a separate account of a sponsoring charitable organization. They can be set up at a wide variety on sponsoring organizations including various large existing charities as well as financial firms such as Fidelity, Schwab, and Vanguard. From this account, donors recommend grants to other charitable organizations. Most DAF programs have the ability to accept appreciated securities as donations. When you contribute a donation (of appreciated securities or cash) to your DAF you get the full appreciated market value of the asset as a tax deduction, in the year of the donation. Upon receiving the gifts the DAF sponsor liquidates the donated assets tax-free and invests the proceeds in a variety of investment options. Generally the donor gets to recommend how the assets are invested among a number of investment choices. Over time the donor can recommend grants to IRS qualified charities and the DAF sponsor distributes cash grants to these recommended charities. Grants may be made over many years into the future even if a large donation was made in just the first year. These DAF accounts are quite easy and cheap to set up. Schwab and Fidelity’s donor advised fund programs require a minimum initial contribution of only $5,000, minimum additional contribution amounts of $500-$1,000, and minimum grant sizes of only $100.

Advantages of using a Donor Advised Fund for your Charitable Giving:

1. An immediate tax deduction of the full appreciated value of the securities donated. You avoid paying any capital gains tax on the sale of the asset. This is much more tax efficient than contributing cash to your charities. You get to give the full appreciated value of the securities to your charities rather than the smaller after-tax proceeds. Make sure you have held the appreciated asset at least a year before donating.

2. Simplification. You making one donation of appreciated securities to your DAF, and then you get to grant multiple smaller amounts of cash to each of your favorite charities. This is much easier administratively than donating smaller amounts of appreciated stock separately to each of your charities (some of which may not accept securities). You only need one tax substantiation letter using a DAF, versus multiple letters if you are donating separately to each charity. DAF’s make it easy to contribute appreciated securities to them. You can also automate your giving from this account on a monthly or other regular basis to your favorite charities. The DAF sponsor does all the administrative and recordkeeping work, and sends the checks to the charities for you.

3. Post-donation appreciation may increase the size of your grants. Since you may donate to your DAF in one year and may grant the money to your charities several years later, any appreciation of the investments during that time will result in larger donations to your favorite charities. Assets in your DAF account can grow faster because they appreciate free of taxes.

4. Good Estate Tax Planning. All donations made to a DAF are removed from the donor’s estate immediately. A large donation to a DAF in the current year may provide many years of future giving to charities and immediately reduces potential estate taxes. Simply planning to give the same amounts directly to charities each year from the donor’s estate provides no shelter from potential estate taxes.

5. Low Minimums, Costs and Ease of Use. As described above many of the programs such as those at Fidelity and Charles Schwab have very low minimums for contributions and donations. They are easy to set up and use and they typically have no startup costs.

6. Ability to donate now and get the tax deduction, and decide where to give later. These funds allow you time (years if you wish) to research and decide where you wish to give.

7. Create a legacy and start a family tradition of philanthropy. DAF’s allow you to get your kids involved in helping pick out the charities and try to teach and inspire them about philanthropy. It is possible to assign your children as successor advisors and extend the grant-advising privilege to them after your death.

8. No minimum distribution requirements or legal red tape like separate tax returns (unlike foundations which must distribute 5% of assets annually and file separate tax returns). Private foundations must pay excise taxes of 1%-2% of net investment income annually, and DAF’s do not.

9. Privacy. Gifts from donor-advised funds can be made anonymously. Private foundations must make their tax returns available to the public, and sometimes families get inundated with requests because of that.

Disadvantages of Using Donor Advised Fund’s:

1. Administrative Costs. While dramatically lower than a private foundation, the DAF sponsors all charge some sort of administrative fee to run the program. These administrative charges cover the cost of keeping track of all the accounts and donations, and distributing the grants. Schwab and Fidelity charge a .60% administrative fee for the first $500,000 in the plan and the fees drop to only about .20% for accounts with $1.5 million or more. These fees have been cut significantly over the past several years. The underlying investment fund options charge a typical expense ratio of about .50-.65%. Other DAF sponsors may charge significantly higher fees that this.

2. Donations are Irrevocable. Once you donate the money to your DAF you can’t get it back. You are still in control of it, but it can only be donated to charities and given away. Only donate what you are sure you won’t need yourself or for other purposes.

3. Restrictions. You can’t use a grant from your DAF to make good on a personal pledge to a charity. You also can’t donate to a charity with the expectation of any personal gain or benefit (concert tickets, etc.). In some DAF’s the investment choices are somewhat limited.

4. No Income to You. DAF’s are not a technique if the donor wants income for themselves or their family from the donated asset. If income is a priority, the donor should consider other vehicles such as a Charitable Remainder Trust.

5. No Ability to Hire Staff. Since all of the administrate work is done by the sponsoring organization, the donor themselves cannot hire family members to do the work as they might with a private family foundation.

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Charitable Giving and Your Personal Finances

Philanthropy is Full-Anthropy

Has anyone ever asked you what you would do if you had all of the money in the world? Most commonly, people respond with, “I’d buy a bigger house or travel.” This is often followed by, “I’d donate more money to charity.”

People who are charitably inclined usually are living a rich, full life. We all have some affinity to a specific charity we like to support. As a Financial Life Planner, I have come to learn that charitable giving is an important goal for most people. Yet most of us don’t have a process for funding this goal.

A simple way to meet your charitable goals is to contribute to a Donor Advised Fund (DAF). A DAF is like a holding account created by a sponsoring charity that holds contributions from various donors and manages the charitable donations. The DAF will send you a quarterly statement of your contributions, along with a gift receipt for tax purposes. These contributions can then be distributed to qualifying charities at some point in the future.

You can usually deduct the full value of the charitable gift – whether it is appreciated stock (avoiding capital gain), or cash. The deduction is subject to adjusted gross income limitations. The gift is irrevocable and is also separate from your estate. Any income or growth in the fund is not tax deductible BUT is exempt from taxes. Once the gift is made, you can recommend how the donation is invested, through asset allocation strategies. You can name successors to the account, who then can manage the fund and make grant recommendations. This provides for a legacy of giving that can last for many generations.

You can get your kids or spouses involved and create your own account title. I know families who have semi-annual meetings with their kids and grandkids to discuss where the grants should go. What a great way to introduce philanthropy to kids!

The DAF accounts can be set up with as little as $5,000. You can support multiple charities with a single donation, usually with as little as $100. When you are ready to recommend to the DAF to make a gift to a specific charity, you just fill out a form and mail it to the DAF. The donation from the DAF can be anonymous, or can have your name identified as the donor.

What part do philanthropy and charitable giving play in your value system? Think about causes and organizations you would like to help. Most people that give to charity are happier and healthier. They experience a sense of satisfaction of helping people or specific causes.

John Templeton wrote: “Happiness comes from spiritual wealth, not material wealth… Happiness comes from giving, not getting. If we try hard to bring happiness to others, we can not stop it from coming to us also. To get joy, we must give it, and to keep joy, we must scatter it.”

Please note: This article is for informational purposes only and should not be construed as individualized investment advice.

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Charitable Giving With Retirement Benefits

Retirement funds and charitable planning may not be two areas most people would naturally think to combine. But in many cases, donating retirement benefits to charity can be an ideal solution, both for the donor and the recipient.

The first and best reason to leave retirement benefits to a charity is, as with any philanthropic gift, to benefit the organization. If you don’t want to help a particular charity achieve its goals, there is no advantage to making it any sort of gift. While you can certainly make charitable gifts in more or less cost-effective ways, the point of giving is to transfer assets to a cause you wish to support. Leaving retirement benefits to charity may help achieve other estate planning goals, as I will discuss later in this article, but only if philanthropy is already a priority.

That said, once you have one or more charities in mind, few people want to cut the government a larger piece of the pie than necessary. Giving retirement plan dollars to charity can be a highly tax-efficient use of your savings. Note that, throughout this article, the retirement benefits I am discussing are those where distributions typically trigger income tax, such as traditional IRAs or qualified retirement plans. Roth plans, where distributions are income tax-free, do not offer any particular advantage for charitable giving.

Since charities are exempt from income tax, they can receive gifts of retirement benefits tax-free, as long as the gift is structured correctly. Retirement plan assets are therefore worth more to a charity than they would be to an individual who would have to pay tax on any distributions.

In contrast, an inheritance is not considered income, so inherited cash would not be liable to income tax. Heirs must pay capital gains tax on other inherited assets such as stock or bonds, but generally only on gains that occur after the decedent’s death; taxes on gains that accumulated during the decedent’s lifetime are forgiven through a so-called step-up in the asset’s cost basis to its date-of-death value. A retirement plan, on the other hand, does not receive this stepped-up basis.

There are situations in which leaving retirement benefits to charity might not be an ideal estate planning solution. A young individual beneficiary may, in fact, do better to inherit a retirement plan than to inherit an equivalent amount of after-tax dollars. This is because, if he or she makes use of the mechanism that stretches payouts over the beneficiary’s life expectancy, the power of income tax deferral may leave the beneficiary better off.

The minimum distribution rules for retirement accounts also mean that you could end up leaving the charity relatively little if you live long enough to exhaust most of the plan’s value. Long-lived plan participants may wish to consider giving their minimum required distribution directly to the charity each year, or revising an estate plan to provide for the charity in a different way as the retirement plan diminishes in value.

How To Make A Charitable Gift With Retirement Benefits

If you plan to leave your retirement plan to a charity, there are several ways to go about it, each with its own advantages and disadvantages. Maybe the most straightforward way is to simply name the charity directly as the beneficiary of 100 percent of the plan’s value at death. Income tax is easily avoided, and the estate tax charitable deduction is available for the full value of the gift. This method also works if you leave a retirement account to multiple beneficiaries, as long as all of them are charities. With this method, it is important to make sure all paperwork is in order. Some plan administrators may require documentation before allowing the charity to collect the benefits, so it is important to make sure that no one involved is taken by surprise.

If you wish to split a retirement account among several beneficiaries, and not all of them are charities, planning becomes slightly more complicated. The general rule is that either all beneficiaries must be individuals, or none of them can use the life expectancy payout method. If you name your son and a charity as equal beneficiaries of your IRA, unless you take additional measures, your son will be forced to forego the income tax deferral he could otherwise enjoy. Note that if your spouse is the only non-charitable beneficiary, this issue is not a concern, since he or she can simply roll over the share of benefits into his or her own retirement plan.

There are two ways to work around this rule. If the beneficiaries’ interests in the retirement plan constitute “separate accounts,” each account is treated as a separate retirement plan, so individuals can take advantage of the stretch payout options. This method is useful, but risky, because beneficiaries must establish separate accounts by December 31 of the year after the year of the plan participant’s death; if they do not, the less beneficial rules automatically take effect. The other option is for the charity to receive a full payout of its share by September 30 of the year after the year of the participant’s death. In this case, the charity is “disregarded” as a beneficiary and individual or individuals can take distributions as they would if no charity had been named.

You do not have to split up the account by percentages. You can also designate a fixed-dollar amount to go to charity, and leave the remainder to other heirs. However, anecdotal evidence suggests that some IRA plan administrators will not accept such designations on a beneficiary form. In addition, this sort of designation can trigger the same problem discussed above; depending on how the fixed-dollar gift is structured, the option of separate accounts may not be available (though the September 30 payout method will be). If this sort of gift is small, it may make more sense to forego the slight tax benefit and simply make the charitable bequest from other assets and leave the retirement funds solely for individual beneficiaries. Alternately, you could make the gift to charity conditional on payment by September 30, though this will require careful planning to make sure the estate receives the proper charitable estate tax deduction.

There are a couple of other ways to protect the interests of individual beneficiaries when leaving a fixed-dollar amount to charity. You could separate your retirement account into two separate accounts, leaving one entirely to the individual beneficiary, and dividing the other between a set gift to charity and the residue to the individual. While a little of the individual’s benefit may not eligible for stretch payments, the bulk of it is protected. If the account is not separated, you may also be able to count the fixed amount of a gift to charity as the account’s minimum required distribution in the first year after the participant’s death.

Some donors may wish to leave an amount that is neither a fixed amount nor a percentage, finding it more convenient to determine the amount using a formula based on the size of the overall estate or with adjustments depending on other amounts passing to the charity. IRA providers may refuse to accept such designations, however, since the provider has no way to know the total size of the participant’s estate and may not be inclined to get involved in complicated accounting matters. Some providers will allow you to specify that your executor or other fiduciary will calculate and provide the formula amount, relieving the IRA provider of this responsibility. Obviously, in this instance, it is essential that this responsibility is assigned by the proper estate planning documents.

Naming a charity as a beneficiary directly, whether alone or in conjunction with others, may be the most straightforward solution, but it is not the only way to make this type of gift. If it is not feasible to name a charity as a beneficiary for any reason, there are several alternatives. You can leave the benefits to a trust, with instructions that the trustee distribute the assets to the charity. This option, however, creates substantial complexity regarding minimum required distributions and fiduciary income taxes. As an alternative, leaving the retirement benefits to a donor-advised fund, which is tax-exempt itself, will sidestep many of these problems, though donor-advised funds have their own drawbacks as well as benefits.

You can also leave the retirement benefits to your estate, with instructions in your will or other estate planning documents that the executor should then give the money to the charity. The estate is entitled to an income tax deduction for amounts paid or set aside for charity, but as with leaving benefits to a trust, this option is complicated and requires expert knowledge, both at drafting and execution.

If you wish to encourage philanthropy in an individual heir, such as an adult child, you can make a disclaimer-activated gift instead of making a gift outright. For instance, you could name your daughter the plan’s primary beneficiary, with the charity as a contingent beneficiary, specifying that the charity would receive any benefits your daughter disclaims. You may or may not express a wish that your daughter leave all or part of the benefits to the charity. Either way, this disclaimer allows your primary beneficiary to redirect all or part of the benefits to the charity without paying income tax on them first.

Types Of Charitable Entities

Up to this point, I have simply said “charity” when discussing the object of a philanthropic gift. In order to secure the beneficial tax treatment I have mentioned, it is important to understand which organizations are appropriate choices for making a gift of retirement benefits. Most of the techniques in the prior section rely on the assumption that the charity is tax-exempt.

A public charity, which you may sometimes hear described as a 501(c)(3) organization, is what most people mean when they simply say “a charity.” These organizations meet a variety of requirements imposed by the Internal Revenue Service in order to secure and maintain tax-exempt status. Gifts to such organizations present the fewest complications, though it is best to verify that the organization is truly exempt. For most charities, this will not be a problem.

Private foundations are generally also suitable recipients. They are also 501(c)(3) organizations, but are primarily supported by the contributions of one donor or family. While a bit more administratively complex than public charities, private foundations will also offer similar tax benefits (though there are stricter limits for income tax purposes on gifts to many private foundations). There are a few special rules that may come in to play with this sort of gift, which are beyond the scope of this article, so you will probably need advice from professionals with training in this area. Also note that you may not make a disclaimer-activated gift where the individual beneficiary is a trustee or manager of a private foundation and the foundation is the contingent beneficiary.

As mentioned in the preceding section, donor-advised funds are suitable recipients for retirement benefits as well. By leaving assets to a DAF with family members as advisors, you may encourage philanthropy in your heirs while taking advantage of the fund’s income tax-free nature. Take care to make sure that the fund you choose, however, meets the applicable requirements to assure the tax-free nature of the contribution.

Charitable remainder trusts (CRTs) that meet certain requirements are also income tax-exempt. Those that meet the requirements can be suitable recipients for retirement benefit gifts. This strategy can benefit the individual heirs of the trust through an annual payout, either a fixed dollar amount (in a charitable remainder annuity trust) or a fixed percentage of the trust’s value (in a charitable remainder unitrust). Note that, as with many trusts, the administration can be relatively complicated and costly, and it is important to secure expert help in setting up a trust correctly. It is also important to know that qualified plan benefits have certain federal law protections that may mean your spouse must give consent before you can leave such benefits to a CRT. It can sometimes be appropriate to leave retirement account benefits to a charitable lead trust (CLT). However, unlike CRTs, CLTs are not exempt from income tax. For that reason, usually there are better ways to give retirement benefits to a charity (and better ways to fund the trust).

If you wish to support a beneficiary while also giving to a charity, some charities will allow you to fund a charitable gift annuity with retirement benefits. This approach avoids several of the complications created by leaving benefits to a CRT.

You should avoid leaving retirement benefits to a pooled income fund. Such a fund is maintained by the charity that will ultimately receive the gift. The organization pools the gifts of many donors, investing them and paying back a share of the fund’s income to the donor or a named beneficiary. When the donor or beneficiary dies, his or her share of the fund reverts to the charity. Such funds have use in life mainly as a lower cost alternative to a CRT. However, pooled income funds are not income tax-exempt, even if the charities running them are. All the benefits discussed in the previous section would therefore be lost.

Lifetime Gifts

Most people will probably want to continue using their retirement accounts during their lifetime, but this consideration does not apply to everyone. Making charitable gifts with retirement benefits, therefore, does not only have to be an estate planning technique.

In most cases, the only way to give assets in a retirement account to charity during your lifetime is to withdraw the money first. This generally means the withdrawal will be taxed. If you make the gift in the same year as you take the distribution, the income tax charitable deduction could theoretically offset the tax on the distribution. Unfortunately, various restrictions including the percent-of-income limit on charitable contribution deductions, deduction reduction for high-income taxpayers and others mean that this is most likely not the case. Taxpayers who use the standard deduction rather than itemizing will not see any tax benefit from their gift.

Some of these drawbacks can be avoided by using smaller distributions and gifts. In addition, it is worth considering donating your minimum required distribution if you do not need it for other purposes. You must take your MRD annually from IRAs and other plans after a certain age. While it does not receive special tax treatment, you have to take the distribution regardless, and a charitable gift may well bring at least some tax benefit.

At this writing, Congress in considering efforts to revive a rule (which expired in 2013) that allowed individuals over 70 1/2 to transfer funds directly from an IRA to a charity without taking a distribution first. If this option returns, it has narrow limits, but is obviously beneficial for lifetime gifts from IRAs.

Retirement plan participants who take distributions before age 59 1/2 are usually subject to penalty taxes. However, if a young participant wants to pledge annual gifts to a charity, an exception known as the “series of substantially equal periodic payments” might make this possible. Because this exception must meet extensive IRS requirements, you should strongly consider consulting a professional to arrange such a gift.

Some sorts of distributions are not subject to full normal income tax, which may make them better suited to charitable giving. For instance, distributions of employer stock from a qualified plan receive special favorable treatment. Any appreciation above cost basis that occurs while the stock is in the plan is called net unrealized appreciation (NUA), and is not taxed until the stock is sold. If you hold stock that has untaxed NUA, you could contribute it to a CRT, avoiding capital gains tax while generating an income tax deduction.

Thinking about your retirement accounts and your philanthropy together, while not always intuitive, can offer benefits in both areas. Depending on your personal situation and your goals, your retirement benefits could be just the right fit for fulfilling your charitable aims.

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