Kristi Hanson was featured in a Bankrate article that discusses donor-advised funds. You can view the piece here.
With the prospect of a Biden administration potentially raising tax rates and cutting estate tax exclusion amounts in half, some well-off taxpayers may be looking for a way to ease their burden even while contributing to their favorite charities. A donor-advised fund may well be that opportunity.
A donor-advised fund is a charitable-giving account that allows a donor to provide grants to a charity over a period of years. They can be relatively inexpensive to create and maintain, and a donor-advised fund offers donors some ability to manage their tax situation through giving.
Here’s how a donor-advised fund works, why it may be an attractive option for giving and some key benefits it has over a charitable trust.
How a donor-advised fund works
With a donor-advised fund, an individual makes a charitable donation to a fund sponsor, such as a nonprofit foundation or an investment firm such as Charles Schwab or Fidelity Investments. The donor takes a tax deduction in the year the initial fund was established, and then the money can be distributed in subsequent years by the fund sponsor under the advisement of the donor.
Think of the fund like a tax-free pot that holds charitable donations, says Richard Mills, an estate planning attorney at Marcoux Allen, a law firm in Michigan.
Would-be donors should know that once the fund has been created, the money can’t be taken back. When the fund is established, the donor creates the rules for how money is gifted. But technically the sponsor controls the fund and the donor’s advice on what to fund is non-binding.
“That said, it is rare for the sponsoring organization’s board to exercise its variance powers and disregard the advice of the donor,” says Mills.
“The funds that are not granted out each year can be invested and grow over time, making it possible for an initial charitable gift to a fund sponsor to eventually yield far more than that initial gift in total gifts going to end-use charities,” says Jeff Hammond, vice president and director of philanthropy at Van Scoyoc Associates, a government relations firm in Washington, D.C.
But to squeeze a tax advantage out of these funds, you’ll need to itemize your deductions, and that means having deductions that exceed $24,800 for a married couple or $12,400 for an individual taxpayer in 2020 (or $25,100 and $12,550, respectively, in 2021). If you don’t reach at least those thresholds, the donor-advised fund provides no net tax benefit.
So, for example, a couple may have itemized deductions of $20,000 and decide that they want to establish a fund with a $50,000 contribution and reap the additional tax deduction. Together these amounts would push their itemized deductions over the threshold, making the plan advantageous, tax-wise. However, because their itemized deductions before the charitable gift were below the threshold, they’ll only receive a net benefit of $45,200 from the donation.
Why a donor-advised fund may be attractive
“Donor-advised funds have grown enormously in popularity in the last 10 to 15 years because they are easy and inexpensive to create, much like opening any other type of brokerage account,” says Mills.
Mills says that financial advisers are suggesting clients include them in financial plans, while attorneys are incorporating them into their clients’ estate plans. He notes that they’re easier and less expensive than other similar avenues such as a private foundation or a charitable trust.
But this type of fund offers a range of other benefits that can make it a great choice for donors.
The prospect of a changing tax landscape may draw many taxpayers to establish donor-advised funds. The Biden administration has mentioned raising capital gains tax rates on wealthier taxpayers, and it’s also floated the idea of drastically reducing the amount of money that can be excluded from the estate tax and eliminating the step-up in cost basis on inherited assets.
While it’s still unclear what steps a Biden administration may take, it campaigned on higher taxes for higher earners, meaning that a well-conceived plan could reduce your taxes. Whichever way the tax winds blow, a donor-advised fund may be able to help.
“Investors may consider funding donor-advised funds in 2021 and beyond with low-cost-basis stock if basis step-up is eliminated,” says Kristi Hanson, director of taxable research at NEPC, an investment consulting firm based in Boston.
A donor-aided fund may allow you to set up one plan to manage all your charitable giving, and meanwhile the fund sponsor can handle all the administrative work.
“Some donors like the simplicity, where they can make one charitable gift and track one gift receipt, and then have the fund sponsor handle multiple charitable gifts from that fund without the donor needing additional substantiation,” says Hammond.
If it’s established through a community foundation, a donor-advised fund can be used to make anonymous gifts, allowing the donor to avoid attention.
The fund sponsor can help the donor decide which charities to support or how to manage the giving process, providing valuable assistance for newer or less informed donors.
“Other donors may have a liquidity moment where they want to devote cash to charity but are unsure exactly which charities to support,” says Hammond. “The donor-advised fund allows the donor to make the initial gift now, and make grants in the future.”
So donors can claim the tax break now and decide later where to give the funds.
“Young and adult children can be involved in the gift advice process and can be given the opportunity to serve as the fund adviser after the death, incapacity, or resignation of the parent,” says Mills.
Donor-advised fund vs. charitable trust
A donor-advised fund differs from a charitable trust in a few ways, depending on the trust. But a key difference is that with a trust the individual donor can still benefit in some way, whereas with a donor-advised fund the money is effectively given away with no ownership.
“With a charitable lead trust, some of the principal gets distributed to your beneficiaries,” says Hammond. “With a charitable remainder trust, you receive annual income and the charity gets money later.”
“With a donor-advised fund, it’s a completed charitable gift, full-stop,” he says. “There’s no element of continued ownership or control, and no income flow going back to the beneficiaries.”
Private foundations are another avenue for the charitably inclined, though they don’t offer the ease or simplicity offered by a donor-advised fund.
Because of their complexity and expense, a private foundation makes sense only for very wealthy families, says Mills, “especially given the dramatic increase in the estate tax exemption amount in the last twenty years.”
“Middle-class and moderately wealthy families can do the same with a donor-advised fund at much less cost,” he says.
If you’re expecting changes to the tax code during a Biden presidency, those looking to maximize the benefits of charitable giving may want to look into donor-advised funds. So consider adding it to your toolbox when planning your estate and managing your tax situation.
Given the complexity surrounding these planning issues, it’s wise to consult tax and estate advisers to address your particular situation, Hanson says.