Americans are at their most charitable this time of year, with 30% of all annual donations being made in December. This year you may be hearing more about the boom in donor-advised funds — charitable giving tools that let you take tax perks now but delay disbursements until later.
Assets in donor-advised funds climbed nearly 25% last year to $70.7 billion, according to a study by National Philanthropic Trust of more than 1,000 donor-advised funds offered by financial companies, community foundations, and other nonprofits. And charitable gifts from the funds grew 27% to hit $12.5 billion in 2014.
So should you jump on board? That depends on a few key issues. Here’s everything you need to know before you decide how to give.
How They Work
Donor-advised funds are philanthropic vehicles established at a public charity. The funds are being pitched to donors as tax management vehicles that let you take big, immediate tax deductions in boom times, and then dole out money later. “Contributions can vary depending on how the market is doing, but this way granting can remain consistent,” says Matt Nash, Fidelity’s senior vice president of donor engagement.
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The funds are managed by nonprofit entities — usually either a charitable organization under a financial services company (like Vanguard, Schwab, or Fidelity) or a local community foundation. Money grows tax-free while it’s in the fund, but you’ll pay administrative fees, typically on top of any underlying investment costs.
Generally, the more money you have in the fund, the lower the percentage of assets you’ll pay in fees; Fidelity, Vanguard, and Schwab all charge an admin fee of 0.6% for those who have less than $500,00 in assets.
Who Should Use Them
The upfront tax deduction makes these funds particularly attractive when you get a spike in income, like an inheritance or proceeds from the sale of a business, says New York City financial planner Robert Hayden. Because a contribution is treated as a gift to a 501(c)(3) public charity, you can deduct up to 50% of your adjusted gross income for cash gifts and 30% for donated appreciated securities, maximizing your tax benefit.
Donor-advised funds are also a smart bet for people who donate assets other than cash to charity. Many small nonprofits are not equipped to take even stock gifts, never mind complex holdings like real estate or small business shares. By giving the appreciated assets to a donor-advised fund, you avoid capital gains tax, Nash says.
One other potential advantage, says Hayden: If you prefer to remain unnamed, donor-advised funds can often let you make gifts anonymously.
When to Skip
Donor-advised funds make the most sense for wealthier donors — so if you give anything less than a couple of thousand dollars each year, contribute directly to your favorite charities. It’s just not worth paying the administrative fees, for one thing, and most funds won’t even let you in the door with less: Fidelity and Schwab both require a minimum of $5,000 to start an account, and Vanguard and the National Philanthropic Trust set the bar much higher, at $25,000. There may also be restrictions on follow-on donations and grant size. Vanguard, for instance, requires that any further donations be $5,000 or more, and that grants be at least $500.
There are other limitations. You cannot receive any goods or services in exchange for your donation, says Hayden, without running afoul of the IRS. Because you have already received a tax deduction on the full amount of your donation, taking advantage of donor perks, which typically reduce your charitable donation by what it costs the organization to offer such rewards, would be like cheating on your taxes. “I have a client who contributed to his alma mater through a donor-advised fund and was very upset to learn he couldn’t get the homecoming game tickets he usually received as a thank you for giving because of how he donated,” says Hayden. So if you enjoy those fringe benefits, this is not your best option.
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If you expect to keep the money in the fund for multiple years, understand that your investment choices will likely be limited to those offered by the company you opened your account with, says estate planning attorney (and sometime Money contributor) Tracy Craig. If it is a large financial institution, options may be as flexible as any brokerage account, but smaller groups may limit choices to a narrow list of pooled investment vehicles.
Donor-advised funds can only make grants to other public charities that are in good standing with the IRS, Craig says. That means you cannot make gifts to split-interest trusts such as a charitable remainder or charitable lead trust.
Finally, Craig adds, donors should note that donor-advised fund operators are not legally required to follow the donor’s wishes about how to invest the money or where grants should be made. Although most established funds do, she says, “You don’t have absolute control over the fund.”