I’ve recently decided to focus more on charitable giving, now that I’m in the decumulation phase of my life. A lot of my wealthy friends have been using donor-advised funds (DAFs) for their charitable contributions, so I thought it was high time I jumped on the bandwagon. My friend Olaf from MileHighFinanceGuy is here to explain what DAFs are and how to set one up with Fidelity, which is the brokerage firm we both use.
Charitable giving is a cornerstone of American culture. It helps support local communities, marginalized groups, the environment, and society in general. One of the best ways to give is through a DAF. The concept of tax-deductible charitable giving has been around since 1917, when legislators wanted to encourage the wealthy to give more to charity. The first DAFs were created in the 1930s, and they’ve been growing in popularity ever since.
Charitable giving has evolved into a system of optimization. Benefactors aim to put their funds towards causes that provide significant socioeconomic benefits, while also receiving preferential tax treatment. In this post, we’ll focus on how benefactors can maximize tax benefits through DAFs.
A DAF is like a vehicle for giving. You put money into it, much like filling up a gas tank. You no longer have the money, but you now have a vehicle that you can steer towards your chosen goal. You advise the charitable foundation managing the DAF where the money should go. You get an immediate tax deduction and can spread the money amongst various charities over time.
Here’s how DAFs work: You donate to a charitable holding company and receive an income tax deduction in that tax year. If you want, you can invest the donation in various assets for further growth. You then ask the charitable company operating the DAF to disperse the funds to a final recipient(s). There’s no minimum or maximum donation amount, and there’s no timeframe for fund dispersion.
DAFs are often used to donate highly-appreciated securities in-kind, which optimizes tax savings since capital taxes are avoided and income taxes are lower. In simple terms, DAFs are best used to donate securities that will incur more significant tax burdens. By doing so, the donor can deduct the amount without realizing capital gains and concurrently lower their income tax burden. This is a double tax advantage!
You can contribute directly from brokerage accounts. Unfortunately, IRAs cannot contribute to DAFs directly and can only be set as a beneficiary. Still, IRA donations to a charity that is not a DAF can be used to satisfy yearly RMD requirements for those 72 and older without incurring income taxes on withdrawals.
DAF operators like Fidelity and Vanguard Charitable allow the donor to give securities and assets in-kind. These include public stocks, bitcoin, artwork, private business ownership, and more. Before using a specific DAF operator, make sure they can process the securities or assets you want to gift.
Once your donation is complete and your account is funded, you can recommend a grant. The DAF Sponsor is responsible for the funds after your donation and makes all decisions subsequently. However, when you recommend grants, they choose whether to approve them or not.
There’s no minimum donation with Fidelity Charitable. However, it only makes sense to open a DAF if you plan to give a sum that exceeds ~$10,000 during that year. This is because of taxes, fees, and minimums. Under the current tax code, every filer(s) qualifies for a standard deduction of up to $12,950 annually. Therefore, many taxpayers do not itemize their deductions anymore.
To open and operate a DAF at Fidelity will cost 0.60% of assets or $100, whichever is greater. At Vanguard Charitable, the minimum charitable pledge is $25,000, and administrative fees start at 0.60%.
If you recommend investing your donation before dispersing the funds to a selected charity, the investment will have an expense ratio. Fidelity offers indexed and active fund choices, while Vanguard offers indexed ones. While these investments provide the opportunity for growth, they can lose money. If you don’t plan to invest the donation before dispersing the funds to an end charity, select the money market option.
Now, let’s walk through the process of opening a DAF with Fidelity Charitable. First, you’ll need to provide your name, address, and other information typically required when opening a bank account. You’ll also need to select a successor who would take control if you die before the funds are fully dispersed.
Next, you’ll fund your Giving Account by donating cash, securities, or other assets. Then, you’ll choose the number of shares you wish to donate from your different lots. After that, you’ll choose an investment strategy for your donated securities. Once given, the DAF will sell your assets and convert them to this investment strategy.
After confirming the details and submitting, you’ll receive a confirmation. The process usually takes 3 to 6 business days. Once your donation is processed, and your Giving Account is funded in your DAF, you can recommend a grant.
The next step is finding a charity or charities to which you want to send funds. Once you select a charity, you can name the intended use for the donation. For the timing section, you can donate now, in the future, or make your donation recurring.
You will now select where your recommended grant funds from in your Giving Account. Choose whichever holdings you wish to sell and move on to the next step once set. A summary screen will now list the grant details so you can confirm everything is accurate. Once you have reviewed the details, you must agree that the selected charity provides you with no impermissible benefits for your generosity.
Congratulations! You have now recommended a grant using your Giving Account. Now, you wait, log in, and view the “Recent grant activity” screen on the landing screen to see the status of your grant. Eventually, it will switch from final processing to check mailed to check deposited.
When you file your taxes the following year, visit the History section to access your statements to download tax receipts, annual donation amounts, and IRS Form 8283.
So there you have it! You now know how DAFs work and how to contribute to them while maximizing the tax benefits for the impact you want to make! The world is in need, so where will you donate? Have a great day!
