How to Use a Donor-Advised Fund

Donor-Advised Funds or DAF’s are one of the best strategies for giving to charities because it gives you flexibility and major tax advantages, so let’s talk about how to use them.

Traditionally, DAF’s are one of those rich-people-tricks that can look like a tax shelter, but many people can benefit by using them in reality.

What is a Donor-Advised Fund (DAF)

A donor-advised fund is your own personal (giving) savings account. You can set one up with an investment company like Fidelity, Vanguard, or Charles Schwab.

Once you set up an account, you contribute cash, securities, or appreciated assets into the account and receive a tax deduction.

The investment companies charge a small management fee, but you can continue to invest the money within your DAF, and the money grows tax-free.

The big thing to keep in mind is once you contribute the money to your DAF, it’s no longer “your money.” However, you still have control over how the money is given.

That’s because the donor-advised fund is now your “giving” savings account that you can use to give money to qualified charities, but you’ve surrendered the money.

You can never take the money back for yourself.

Why use a donor-advised fund?

Giving is valuable to the receiver as well as the giver. When you create a DAF, your mindset will change from someone who gives to charity to acting as your own charitable organization. 

That’s because you’re now building your own charitable trust, which shifts your focus to a long-term strategic view of your charitable giving.

My wife and I like to give and even endowed a scholarship, but even though the endowed scholarship became a sustaining gift, it left our sphere of influence.

If we would have set up a DAF instead, we could have given annual gifts and managed how the money was invested. 

We also could change where we give our money, instead of locking it in with an endowed scholarship.

How can you maximize your giving?

Donor-Advised Funds provide a huge perk: you can contribute to the fund and receive a tax deduction, but you don’t have to give the money away in the same year.

This creates some unique opportunities if you have a very high-income year. Let’s say you’re expecting a huge bonus or have a large amount of options vesting. 

You can contribute to your DAF to “lower” your income through deductions, and give the money away later as you see fit.

When are good times to use this offsetting feature? 

• Receiving a large bonus that you don’t get every year
• Expecting a high commission year
• Vesting of stock options or RSU’s
• Cashing in a large capital gain

The DAF strategy becomes especially effective if you’re experiencing an increased income in one year, and you’re able to give some of that money away.

That’s because the DAF essentially allows you to double or triple (or more) your giving in any year to offset these one-time income events. 

If your income goes down the next year, you can reduce your giving, but still have money to give through your fund.

The Best DAF Contribution Strategy

One of the most effective ways to fund a DAF is to contribute appreciated stock or other assets. That’s because you get to deduct the full amount, even if a large chunk of the stock is capital gains.

Let’s say you bought $3,000 worth of Apple stock ten years ago that’s now worth $10,000. If you sold the stock and then gave it away, you’d still pay capital gains taxes on the $7,000 gain.

However, if you contributed the $10,000 of stock to your DAF, you would avoid paying capital gains, and you’d get to use the full $10,000 to deduct against your income!

Donor-Advised Fund Case Study

Let’s see how this strategy works in real life.

Alonso, a single 40-year-old who lives in Texas, makes $300k per year in his high tech job. His RSU’s are vesting this year, which means the amount he receives is taxed as ordinary income. 

Let’s see how a DAF can help Alonso:

Salary: $300k

Ordinary income from RSU vesting: $100k

Additional taxes from RSU vesting (Federal only, no income taxes in Texas): $100k X 35% (his top tax bracket) = $35,000!

Let’s say he has a lot of appreciated stock he wants to fund a DAF with. In this example, he has $50,000 worth of Amazon with a cost basis of $10,000.

He can contribute the full $50k and fully deduct it against his income. Let’s assume he’s already over the $12k standard deduction due to SALT and other giving.

That means the full $50k can be used to reduce the income in the top bracket, saving $50k X 35%, or $17,500!

Alonso’s original investment of $10k in Amazon allowed him to save $17,500 in taxes, and most importantly, he’s able to give away $50,000 from his donor-advised fund!

If it seems like you’re creating extra money with a DAF, that’s essentially correct. 

Instead of being forced to sell the stock, pay taxes, and contribute, you can skip the sell/tax part and then receive the full benefit as an income deduction. 

DAF Tax Deductibility

The Tax Cuts and Jobs Act of 2017 increased the standard deduction to $12k for single filers and $24k for married filing jointly.

This is a good thing for most people, but it also means you’re less likely to itemize deductions. To receive the charitable giving deduction, you must itemize.

You’re also limited on how much you can deduct. Currently, you can only deduct up to 30% of your adjusted gross income (AGI) on appreciated assets, but you can deduct up to 60% of your AGI with a cash donation.

Additionally, for 2020 only, the CARES Act allows you to deduct up to 100% of cash donations, but it has to go directly to a qualified charity and not to your DAF. 

 If you have a big giving year, you can carry any excess above the 30%/60% of AGI forward over the next five years.

Donor Advised Funds Limitations

The biggest limitation of the donor-advised fund is once you contribute the money, there’s no getting it back! Make sure you’re able to live without this money.

Another downside is you’ll pay a management fee, which is typically less than 1%, but this is a small fee for having your own charitable giving organization.

New accounts require a minimum contribution to get started, which is $5,000 for Fidelity and Schwab and $25,000 for Vanguard.

Now you have another rich-person trick up your sleeve to use the Donor-Advised Fund and maximize your giving. 

If you’re pursuing early financial independence or early retirement, but still want to give after retiring, the donor-advised fund is a great strategy because it allows you to contribute in your high-income years and give later when your income may not be as high.