Estate Planning Q&A: Donor advised funds explained

A donor advised fund (DAF) can be a valuable tool for charitable and tax planning. When strategically utilized, contributions to a DAF offer significant advantages, including the ability to recommend future charitable distributions and reduce your estate.

What is a DAF?

A DAF is a charitable giving vehicle that is legally owned and controlled by a sponsoring organization (typically part of an investment advisory firm’s charitable vehicle or a community foundation).

How does a DAF work?

When you contribute to a DAF, you are making an irrevocable donation to a charitable organization, which sponsors and manages the fund. You can make recommendations on how the money is invested, as well as amounts, dates and recipients of subsequent charitable distributions from the DAF. While you are granted varying advisory privileges, the sponsoring organization in control of the DAF has final say over what happens to the funds in the account.

What are the benefits of using a DAF?

• You receive an immediate income tax deduction for your contribution, subject to income limits, even though a distribution to charity from the sponsoring organization may not occur until later. Contributing to a DAF in a year when you have higher income than usual can allow a greater income tax deduction.
• You can recommend grants to your preferred charitable organizations over time.
• The sponsoring organization handles the administrative tasks such as maintaining records, reporting requirements, review and approval of grants, and distribution of funds.
• The funds held in the DAF can be invested, and since a DAF is managed by a public charity, the investment income generally is not subject to federal income tax.
• Contributing assets to a DAF removes them from your estate, as well as any post-contribution growth, which will reduce your estate tax liability.

What are the potential downsides of utilizing a DAF?

• The immediate income tax deduction may be subject to limitations.
• Certain sponsoring organizations may not be willing to accept or invest in certain types of complex assets (e.g., closely held stock, alternative investments, etc.).
• Certain transactions by or with the DAF are prohibited (e.g., excess business holdings, distributions that benefit the donor/advisor, etc.)
• As with other charitable contributions, gifts made to a DAF are irrevocable, and you relinquish control to the sponsoring organization.
• While you can recommend grants, the final decision rests with the sponsoring organization, which is not legally bound to follow your recommendations.
• There may be administrative and investment fees associated with the fund, which can vary depending on the sponsoring organization and the types of investments held within the DAF.
• Some sponsoring organizations require a minimum contribution from donors and may set minimum thresholds for grants made to other charities.
• DAFs have been the focus of scrutiny, and while there are currently no mandatory payout requirements, there have been legislative proposals that, if enacted, may implement annual payout requirements or otherwise affect the charitable contribution deduction.

Is a DAF right for you?

Contributing to a DAF can be a simple and flexible strategy to make charitable donations. However, the decision to use a DAF requires careful consideration of its benefits and limitations. As always, consult with your RSM US tax advisor to tailor a strategy that best suits your situation and goals.