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Estate Planning: Want flexibility? Consider a Donor Advised Fund

 

Benefits, Risks and Getting Started with this Flexible Charitable Option for High Net Worth Investors

High net worth investors have the ability to take advantage of the benefits and flexibility that come with donating cash, securities, or other non-publicly traded assets directly to qualified 501(c)(3) organizations.

Charitable donations allow you to transfer wealth out of your estate while also receiving a tax benefit and making an impact with the qualified organizations you support. However, the value and timing of the tax benefit realized depends on the type of asset, the year in which it was donated, and the overall tax situation of the investor.

One way to maintain control and realize the benefit of your donation in the year that is most valuable to you is to utilize a Donor Advised Fund.

What is a Donor Advised Fund and what are the Key Benefits of this Type of Charitable Account?

A Donor Advised Fund is a charitable account that is sponsored by a public charity. This type of account offers several key benefits to you as the donor:

  • Allows you to make irrevocable donations to your Donor Fund and receive tax deductions in the years the donations to the Donor Fund are made.
  • Allows you to recommend grants out of the fund over time to your qualified charities of choice at whatever pace desired.  
  • Allows you flexibility as to how the pool of assets should be invested, which can even include alternative investments once you surpass certain asset levels (account specific).
  • Allows you to reduce the need to track charitable receipts and tax deductions to direct charities. For example, if you donate $100,000 of appreciated long-term securities to the Donor Fund, you only need the tax receipt for this donation, and do not need any of the receipts for the subsequent grants out of the Donor Fund, saving lots of time and hassle of tracking each and every charitable contribution!
  • Potentially gets more money to your qualified charities of choice.  Not only does the money within the Donor Fund enjoy tax-free growth, but you save on a capital gains tax that you otherwise would have had to realize if you sold the securities and given the charity cash net of taxes paid.  

According to the National Philanthropic Trust, Donor Advised Funds have been gaining popularity in the U.S. over the last few decades as investors have been catching on to this useful tool for charitable giving that provides additional flexibility within a wealth strategy.   

Although this investment vehicle was created in the 1930s, it’s been gaining traction steadily since the 1990s. The number of funds, donations into the funds, and recommended grants out of the funds have all risen year over year for at least the last eight years. In 2017, assets in these funds also surpassed $110 billion–a new record!

Capitalizing on the Flexibility of a Donor Advised Fund

Because you can realize the maximum allowed tax deduction in the year the assets are donated to the fund, you’re able to pick and choose which tax years are most beneficial for your personal situation–such as a higher income year than normal–while continuing to make grants to the charities that are most important to you year over year.

In addition to providing timing flexibility, this charitable vehicle also makes it easier to donate non publicly-traded assets and private interests that a charity otherwise may not be able to take directly.  

As a high net worth investor, you may have already started a Private Foundation for some of the same benefits that a Donor Fund provides, such as being able to recommend investments, granting out to other charities at later points in time, and helping with family legacy planning by enabling the next generation to take over grant-making decisions. However, there are some differences worth noting that may make the Donor Advised Fund more appealing:

  1. They are less expensive to start up and run. Foundations have ongoing administrative costs that are higher than Donor Funds, in addition to excise taxes on net investment income annually (typically 1-2%).
  2. They have a higher Adjusted Gross Income (AGI) limit for tax deductibility of donated assets, which means you may be able to deduct more by donating to a Donor Fund versus a Foundation:
    1. Donated cash; DAF = 60% of AGI; Foundation = 30% of AGI
    2. Stock or real property; DAF = 30% of AGI; Foundation = 20% of AGI
  3. They aren’t required to pay out a certain amount every year, unlike Foundations, which must make a required minimum distribution of 5% each year. Although The Donor Advised Fund sponsor is required to distribute 5% of assets each year, this requirement has yet to be an issue at the individual account level.  
  4. They can provide more privacy than Foundations since they have the option to recommend a grant anonymously and don’t need to file anything publicly. Foundations have to file public tax returns naming trustees, charities, grant amounts, salaries, etc.

Some Risks of Utilizing Donor Advised Funds

Not all assets hold the same weight when it comes to the tax benefit that will be received in exchange for the donation. Donating long-term, highly-appreciated assets instead of cash is more beneficial and reduces the amount of capital gains tax that would have otherwise been paid if you sold the assets first.  Just like all donations, you need to be mindful of which assets are being donated into the sponsored fund.

Additionally, you’ll want to make sure the fund is titled in a way that you would want to be recognized (i.e. The Smith Family Gift Fund). However, grants out of these funds can usually be made anonymously, which you may prefer.

Also, you cannot recommend legally-binding pledges from your Donor Fund because you cannot receive an incidental benefit from the grant, which may put the irrevocable nature of this account at risk. Therefore, a Donor Fund can’t make a grant that would relieve you of your financial obligation. However, you can make a non-legally binding intention to qualified charities of your choice.      

Finally, just like any donation, the gift is irrevocable, meaning that wealth is no longer included in your estate and can no longer be used for personal needs once it is donated.  

How to Take Advantage of a Donor Advised Fund

Getting started with a Donor Advised Fund is simple and usually requires a minimal initial donation amount to be made. The fund can likely be opened with your existing custodian (such as Fidelity, Charles Schwab, or your community Foundation), which makes it even easier to keep track of and use for your charitable giving!

 

By Carolyn B.R. Decker, CFP®, CPA, PFS, Partner, Lake Street Advisors

Please see the original article at Lake Street Advisors.

 
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