With the recent rise in tax rates, high income earners are seeing tax rates increased on both earned income, and investment income. A donor advised fund is a charitable gifting vehicle directed by a public charity and established for the purpose of managing charitable donations on behalf of an organization, family, or individual. For high income earners with charitable intent, donor advised funds can provide a tremendous tax benefit, and a pool of assets to distribute to any 501c (3) charity. Below are a few things to know about donor advised funds:
Donor advised funds have a tremendous tax benefit
There are two main benefits of donating to a donor advised fund.
- You are able to donate appreciated assets without realizing capital gains on these assets. Because earnings within the donor advised fund are tax-free, this will eliminate your future capital gains taxes for disposing of these assets.
- You will also receive a full charitable deduction for the value of the assets you put into the fund in the year of contribution. By donating to a donor advised fund, you are effectively frontloading a “ready reserve” of charitable dollars, which can be invested for potential future growth. That “ready reserve” can be used over time to support any 501 (c)(3) charitable organization.
- For example: If you have a $100,000 asset with $50,000 of unrealized gains, donating the entire asset will save you $11,900 in capital gains taxes (assuming gains are taxed at 23.8%), and $39,600 in income tax (assuming you are in the 39.6% tax bracket). This is an excellent way to eliminate capital gains tax on disposition of an asset, as well as reduce federal income tax by making a large charitable contribution.
Donor advised funds also have cost and administrative benefits
- Donor advised funds typically incur lower costs than private foundations, which can incur tax, administration, and audit costs.
- Rather than verifying the charitable status of the organization you choose to distribute to, the sponsoring organization of the donor advised fund verifies charitable status of all organizations.
The tax benefit comes with a few restrictions
There are a few things to keep in mind before donating to a donor advised fund:
- The contribution you make is irrevocable, meaning if you run out of money, you can’t tap into the donor advised fund. Make sure you are comfortable with the amount of assets held outside the donor advised fund prior to making any contributions.
- You do not receive a charitable deduction when funds are distributed from the account. Because you are able to receive a full deduction on your contribution into the donor advised fund, when charitable contributions are made from the fund, you do not receive any tax benefit.
- When you gift assets to a donor advised fund, you are technically gifting assets to a “sponsoring organization” that has ultimate control over the funds. Although almost all grant requests are implemented, the sponsoring organization has the final say in which organization the funds are paid out to.
- Depending on the size of the donation, many donor advised funds have limitations on investment options.
When donor advised funds make the most sense
It’s time to consider establishing a donor advised fund when you have appreciated assets, and a lifetime charitable intention greater than $10,000 (donor advised fund minimums begin around $10,000). From a timing standpoint, the best time to make a gift to a donor advised fund is when you are at the peak of your lifetime earnings. This will allow you to get the largest tax benefit due to being in the highest tax bracket.
Donor advised funds definitely aren’t for everyone. For the “super donor”, with lifetime charitable intent exceeding $5 million, a private foundation may offer the flexibility and control to justify the increased costs. For someone making small donations, they may not meet donor advised fund minimums ($10,000 and above). However, for high tax bracket individuals and families with significant charitable intent, donor advised funds are a great tool to have in the toolbox of gifting strategies. Because every situation is different, and many factors have to be taken into account (such as AMT, limitation of charitable deductions, and ability to afford a large donation), it is important to consult with your financial planner and/or tax advisor prior to establishing a donor advised fund.
By: Adam Glassberg CFP® CIMA® – July 9th, 2014