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Is a Donor Advised Fund Right for You?

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In coming decades, trillions of dollars are expected to be transferred by baby boomers to charities. Instead of working through foundations and endowments, however, most of this U.S.-based philanthropy is expected to be made by individual donors and their families.1

"It's easy, amid press stories about the projects of large foundations or corporations, to forget that the vast bulk of American philanthropy is carried out by individuals," notes the Almanac of American Philanthropy. "Between individual donations and bequests in wills, personal gifts come to over four times as much, every year, as what behemoths like the Gates, Ford, Walton, etc., foundations plus corporations give away."2

The fastest growing investment vehicle to pass money and other assets to charitable causes are Donor Advised Funds, according to the Philanthropy Roundtable, publisher of the Almanac. In fact, the nonprofit group estimates that DAFs have grown in popularity to outnumber private foundations by more than two-to-one. 

In its latest annual market report, the National Philanthropic Trust pointed to industry data showing DAF contributions surpassed $37 billion in 2018. That represented an 86% increase in donations over the last five-year period tracked.3

"The rapidly increasing number of individual donor-advised fund accounts make them the fastest-growing vehicle in philanthropy," the trust noted, "and the rising value of charitable dollars granted from donor-advised funds also makes them the most active philanthropic vehicle."

A Donor Advised Fund is a charitable giving vehicle administered by a public charity created to manage charitable contributions on behalf of individuals and families. The giver opens an account in the fund, which can be held at a major brokerage firm such as Charles Schwab or Fidelity. Along these same lines, he or she can continue to work with an IFA wealth advisor. 

Here's how it works. After transfering cash or securities into the fund, you become eligible for a tax deduction and won't be required to pay capital gains on those appreciated assets. At the same time, you're typically allowed to pick the time and amount of your donations, as long as such gifts are made to an IRS-certified 501(c)(3) charity. 

The level of the tax deduction is up to 60% of adjusted gross income for cash and 30% for appreciated investments. Again, there are no taxes on any capital gains or income that occur inside a DAF.

Donations are allowed in several different forms. These can include non-public as well as publicly traded securities, real estate, private investments and shares of mutual funds. You should be aware, however, that different rules and restrictions apply when donating real estate, non-publicly traded and other alternative types of assets. As a result, IFA's wealth advisors recommend checking with a DAF's sponsor before starting any gifting process. 

Below are some other major factors to keep in mind about using a DAF when trying to decide about how to make any charitable contributions in a tax-efficient manner. This list represents the collective insights of our investment committee as well as John Dahlin, a Certified Public Accountant (CPA) and head of IFA Taxes.

Diversification of Holdings 

An advantage of investing through a DAF is that donors can diversify highly appreciated and concentrated positions without tax ramifications. The benefits of diversification inside such a charitable fund is that it can maximize expected returns and leave them with more assets to donate to the charities of their choice.  

Based on research by leading academics such as Eugene Fama and Kenneth French, we're confident that using a globally diversified and passively managed portfolio of index funds provides a donor with the best opportunity to maximize expected returns over time. IFA's portfolio managers have found that thoroughly researched diversification strategies can reduce portfolio volatility – without sacrificing expected returns. 

Nobel Laureate Harry Markowitz was one of the first academics to research and document the investment benefits of adding additional assets to a portfolio. His work in understanding risk and how it applies to stock markets was seminal in the development of what became known as modern portfolio theory. This appreciation of modern portfolio theory's attributes is why each IFA Index Portfolio is designed to provide clients with exposure to more than 13,000 companies across 40-plus countries. 

Besides diversifying across asset classes, academic researchers like Fama and French have identified certain criteria as major drivers of expected returns – as well as key determinants of investment risk. These premiums available to investors include characteristics (or "factors") of stocks such as size, value and profitability. As a result, IFA's portfolios are built using index funds that emphasize these factors. 

Investment Minimums and Portfolio Guidance

Typically, donors can pick investments using pre-selected portfolios offered by the DAF sponsor. But in DAFs referred by IFA, they can also choose to work with their wealth advisor to invest in a customized portfolio using a variety of different mutual funds and ETFs. (IFA accepts no referral fees or direct compensation from DAFs.) 

With this option, however, it's important to check minimum account requirements since such investment thresholds can vary greatly across different charitable organizations. 

In general, DAF sponsors don't set account size minimums as high to use their pre-set inventory of funds. For example, the charitable organizations established by Schwab and Fidelity to oversee DAF programs have no minimum investment requirements to open an account. To work with an advisor to help design and implement your portfolio, though, both DAF programs require at least $250,000 to get started. 

Another charitable organization that IFA has referred clients to in the past is the American Endowment Foundation. The Ohio-based philanthropic group mainly works with donors using investment portfolios designed by their advisors. To set up a DAF account, AEF requires a minimum of $10,000 in assets. 

"We're not offering a choice of certain funds to invest in because we think it's important for clients to discuss with their advisors how best to set up any charitable portfolios and make sure those allocations are consistent with their other investments," says Ken Nopar, a senior philanthropic advisor at AEF.

IFA also works with Investors Philanthropic, which is another independent charitable group. The Newport Beach, Calif.-based DAF sponsor encourages donors to work alongside their wealth advisors. 

Typically, it requires an initial account size of $100,000. For IFA clients, however, the organization will "consider customizing account minimums to consider each donor's specific charitable planning needs," says Valentina Khan, managing director at Investors Philanthropic. 

Like AEF,  the DAF platform offered through Investors Philanthropic allows for an individual's advisory firm to be involved in many of the back-office functions involved in managing their DAF accounts. 

Along with letting advisors and their clients work together on portfolio decisions, including an investor's wealth manager in the administration process helps to make for a more "seamless" and "efficient" DAF experience, points out Khan. "Just like with a regular portfolio held at IFA," she says, "your sensitive investment information is overseen by your wealth advisor. So if there are any questions, you've got two levels of support -- our organization as well as your IFA advisor."

Managing Paperwork and Complexity

The costs and minimum account sizes required by a DAF are likely to be far lower in general than establishing and maintaining a private foundation. It's also probably going to require much less in terms of paperwork, legal fees and related complexities necessary to setting up and maintaining a foundation.

In fairness, however, a private foundation has the advantage of not being limited to giving only to charitable organizations. Foundations are also sometimes utilized as a means of employing family members.

It might be worth considering, however, that investing through a DAF can still provide a means to involve your family members in philanthropic and other transfer-of-wealth decisions. In fact, a DAF can be used as a tax-efficient companion vehicle to a charitable trust – or, to a private foundation. It can also generally be used to accept donations from any of these vehicles. 

Estate Planning Benefits and RMDs 

One of the ways DAFs are most frequently used is as an estate planning tool. DAFs are particuarly well-suited to distributing assets not only to charities, but also to successor donors after a DAF's last account holder has died.

In terms of estate planning, this can open up avenues for an estate to continue its philanthropic activities as assets held in such funds can be passed along to a new generation of wealth builders. 

DAFs can also serve in some cases as a useful estate planning tool for dealing with Required Minimum Distributions. But you're going to need to be aware of some caveats in using RMDs to place your estate in a better tax-advantaged situation. 

Technically, the IRS will allow investors aged 72 or older to use up to $100,000 each year of their RMDs for charitable donations. 

However, DAFs and foundations aren't eligible for such gifting purposes. But a practice that some families are implementing is to make a DAF the charitable beneficiary of the DAF. In this manner, assets can be passed from one tax-efficient vehicle to another between generations. 

Each person's situation can vary greatly, of course. IFA's wealth advisors typically recommend clients with estate planning questions talk to an attorney specializing in that field. 

Fees and other Costs

So how much does it cost to use such funds? 

To compensate the sponsor for the administrative expenses of running a DAF, there is an annual fee that will vary with the size of the account. For both Schwab and Fidelity's charitable organizations, the annual fee is 0.60% for the first $500,000 and tiers down from there. 

The American Endowment Foundation charges annual management fees of 0.70% up to the initial $500,000. By contrast, Investors Philanthropic is offering IFA clients a discounted fee of 0.55% a year. As asset thresholds rise, each firm charges lower rates on a tiered basis. Both independent DAF sponsors are set up to work with Schwab and Fidelity as custodians. 

IFA can help you to research specific DAFs and discuss broader philanthropic strategies, both in terms of investing and tax-related issues. We invite any clients who are considering how best to engage in philanthropic endeavors to contact their respective IFA wealth advisor. Initial consultations are free-of-charge for both advisors and IFA Taxes' Dahlin. You can contact either by calling: (949) 502-0050. 

Footnotes:

1). National Philanthropic Trust, "Family Philanthropy & Donor-Advised Funds: Engaging the Next Generation," Nov. 25, 2020

2.) Philanthropy Roundtable, "Almanac of American Philanthropy," 2017.

3.) National Philanthropic Trust, "2019 DAF Report," 2019. 


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Investing involves risks, including possible loss of principal. This is intended to be informational in nature and should not be construed as tax advice. IFA Taxes is a division of Index Fund Advisors, Inc.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com

Certified Public Accountant (CPA) is a license to provide accounting services to the public awarded by states upon passing their respective course work requirements and the Uniform Certified Public Accounting Examination.