As the holiday season approaches, you might feel the holiday spirit to give to a good cause. Yet many people are unsure how they work or whether they’re the right tool for their philanthropic goals. What if there was a way to do more than just a simple donation? What if you’re looking to take a sizable amount of your wealth for a good cause? Well let’s get you acquainted with the account for just those purposes.

What Is a Donor-Advised Fund (DAF)?

A donor-advised fund (DAF) is essentially a charitable investment account. You contribute money or assets to the fund, and then it recommends grants to your favorite charities over time. As a charitable donation, this can potentially be used as a tax deduction. Think of a DAF as a charitable savings account that gives you flexibility and control over when and how you support causes you care about. It has several appeals to it:

1. Immediate Tax Deduction

If you opt for itemized deductions over the standard deduction, you can add this to your list. Doing so provides an easy benefit, especially if you’re looking to reduce your taxable income for the year.

2. Capital Gains Elimination

If you donate appreciated stock, you do not need to sell it and realize any gains. Furthermore, the charitable organization using the proceeds for charitable purposes also does not pay for them. Therefore, you can eliminate your capital gains treatment altogether.

3. Simplified Recordkeeping

Instead of tracking individual donations throughout the year, you only need to keep records of contributions made to the DAF. The fund manager handles the details of distributing grants to charities.

4. Flexibility in Giving

A DAF allows you to separate the timing of your tax deduction from the timing of your charitable gifts. You can contribute assets during a high-income year but distribute the funds to charities over several years.

How Do Donor-Advised Funds Work?

The mechanics of a DAF are straightforward but it's good to review the process.

Contributions

You can contribute a variety of assets to a DAF, including:

• Cash
• Publicly traded securities (stocks, ETFs, mutual funds)
• Private business interests or real estate (depending on the fund sponsor)

Donating appreciated assets, such as stocks, can provide additional tax benefits. As mentioned, you’ll avoid capital gains taxes on the appreciation of the investments while receiving a deduction for the full market value of the asset.

Tax Deduction Limits

The IRS limits how much you can deduct for charitable contributions:

• Cash contributions: Up to 60% of your adjusted gross income (AGI)
• Appreciated assets: Up to 30% of your AGI

For example, suppose your AGI was $420,000 for the year. You could deduct up to $140,000 worth of stock and take the amount as an itemized deduction for the year.

The excess can be carried forward for up to five years if your contributions exceed these limits.

Investing Within the Fund

After contributing to the DAF, you can choose how the assets are invested. Common investment options include money market funds, mutual funds, and ETFs. The tax-free growth within the fund means more money for charitable giving in the future.

Grant Recommendations

When you’re ready to give, you can recommend grants to qualified 501(c)(3) charities. The fund sponsor reviews and approves these recommendations to ensure compliance with IRS rules. Grants can often be made in your name, anonymously, or in honor of someone else.

Considerations Before Opening a DAF

While donor-advised funds offer many benefits, they’re not without limitations. Here are a few things to keep in mind:

• Irrevocable Contributions: Once assets are contributed to a DAF, they cannot be withdrawn for personal use.
• Fees: DAF sponsors charge administrative fees, which can vary by provider.
• Grant Timing: Although you control the timing of grants, there are no requirements or deadlines to distribute the funds. This flexibility has drawn criticism from some who argue it delays charitable impact.

The Bottom Line

Donor-advised funds are a versatile and tax-efficient tool for charitable giving. They offer immediate tax benefits, simplify recordkeeping, and promote strategic, long-term philanthropy. Whether you’re looking to support a favorite cause, maximize the impact of your assets, or create a charitable legacy, a DAF can be a valuable addition to your financial plan.

As with any financial tool, it’s essential to understand the rules and limitations. Work with a financial advisor or tax professional to determine if a donor-advised fund aligns with your goals before implementing and to develop a strategy that maximizes your charitable impact.

But if you're looking to make an immediate impact before the end of the year, this is an option worth considering!

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