What’s the Point of a Donor-Advised Fund?

The following is an excerpt from my book More Than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need.

A donor-advised fund is a nonprofit entity, often run by a financial institution (e.g., Vanguard, Fidelity, or Schwab). When you contribute money to the fund, it counts as a charitable contribution for tax purposes (i.e., you get an itemized deduction). And money you contribute to the fund goes into an account over which you have (limited) control. The money is no longer your money—you can’t take it out and spend it on groceries. But you maintain control of how it is invested. And at any time you can choose to have distributions (“grants”) made from the account to one or more charities of your choosing. (Such grants have no tax impact for you, because you’re not actually a party to those transactions. They are transactions between the fund and the ultimate charities.)

There are three main reasons why you might benefit from using a donor-advised fund:

1. You can get the tax deduction now, without yet needing to figure out how much you want to give to which charities.
2. They provide anonymity, if desired.
3. They make it easier to donate securities (e.g., shares of mutual funds or stocks).

Note that none of these is a tax benefit.

Some companies that run donor-advised funds promote them as if they offer tax benefits, when in reality it’s just the same tax benefits that come from charitable contributions in general. That is, you don’t save any taxes with a donor-advised fund that you wouldn’t have saved by simply donating directly to the ultimate charitable recipient(s) instead of donating to the donor-advised fund.

The benefits offered by donor-advised funds are administrative benefits. But these administrative benefits can be valuable.

Deduction Now, Decide Recipient Later

Just to reiterate, once you’ve contributed money to a donor-advised fund, that money is no longer your money. You cannot take it back out to spend on groceries. You cannot distribute the money to your nephew, even if he really needs it. And the money does not go to your kids when you die. So, in that sense, the donation decision is final as of the date that you contribute to the fund.

But there might be years when, based on your budget and tax planning, you decide that you want to make charitable donations of $X. And it’s often the case that this decision is made close to year-end (i.e., after you have a good idea as to your various amounts of income/deductions). And you might not, right at that moment, want to have to figure out exactly how many dollars go to which charities. So you can make a contribution to the donor-advised fund, and then take your time with determining the ultimate recipients of the dollars. (Though the ultimate recipients do have to be charitable organizations.)

Many people use donor-advised funds to implement a deduction bunching strategy. Deduction bunching can be done without a donor-advised fund: just make large donations every several years rather than smaller donations every year. So again, the donor-advised fund isn’t providing any additional tax savings. But with a donor-advised fund you can make the tax/budgeting decision now and decide which charity ultimately gets the money later. Again, not a tax benefit, but a real administrative benefit.

Anonymity, if Desired

The overwhelming majority of donations made in the U.S. are not anonymous. And that’s not terribly surprising. Most people want to be thanked. Plus, the simplest ways of donating to a charity (i.e., writing a check or pulling out the credit card) result in donations that aren’t anonymous.

But if you want to remain anonymous for any reason (even if that reason is just to stay off the mailing lists), donor-advised funds can be helpful. That’s because, when you make a grant from the fund to a charity of your choosing, you can select whether the grant will be anonymous or not. If you choose to remain anonymous, the charity would see, for example, that the donation came from Fidelity Charitable, but they wouldn’t know who the actual original donor was. The donor-advised fund serves as a middleman, shielding your identity.

Simplification of Donating Securities

When you donate assets that a) are not held in retirement accounts such as an IRA, b) have gone up in value, and c) you have owned for longer than one year, you get to claim an itemized deduction for the current market value of the asset and you do not have to pay tax on the appreciation. As such, donating such appreciated assets can be a very tax-savvy way to give.

But many charities, especially smaller ones, simply aren’t set up to accept donations of anything other than cash.

Donor-advised funds, on the other hand, are ideally situated to accept donations of securities, given that they’re often run by financial institutions. In fact, if your donor-advised fund is through the same company where you have your taxable brokerage account, the web interface will generally have a very easy way to simply select shares for donation and have them transferred to the donor-advised fund. And then from there, the fund can make a cash grant to the charity of your choosing.

What About Tax-Free Growth?

Sometimes people promote donor-advised funds by mentioning that they allow the money to remain invested and grow, tax-free, prior to being distributed to the ultimate charity. But this benefit is just an illusion. If you donate money directly to a charity, that charity can invest the money, and any gains that they earn will be tax-free (because they’re a tax-exempt organization).

Some people counter that most charities would not choose to invest the money (i.e., they would spend it shortly after receiving the donation). That may be true of course. But when you donate to a donor-advised fund and invest the money for some years, rather than donating immediately to the ultimate charity, all that is achieved in this regard is that you have deprived the charity of the choice to spend the money immediately. In most cases I would argue that the charity itself has better knowledge of its goals, plans, and financial circum­stances than the donor would have and is therefore in a better position to make this decision.

Drawbacks of Donor-Advised Funds

While donor-advised funds do offer useful administrative benefits, there are drawbacks as well.

The first downside is the cost. In addition to the costs of the investments held in the account, donor-advised funds typically charge an administrative fee as well. For instance, as of this writing, the donor-advised funds from Vanguard, Fidelity, and Schwab each charge an administrative fee of 0.6% per year (with a lower percentage for larger accounts). That said, the smaller the balances in question—and the shorter the length of time that money is left there—the less important such costs are.

A second potential downside of donor-advised funds is that they often impose a minimum grant size (i.e., for when you direct money to be distributed from the fund to a charity). In some cases though, that minimum is very modest (e.g., $50 at Fidelity or Schwab, as of this writing).

A final downside is simply that donor-advised funds cannot be the recipient for a qualified charitable distribution from a traditional IRA. So if you want to take advantage of QCDs, you must, at that time, determine the ultimate charity to which you want the money to go.

Simple Summary

• A donor-advised fund is a non-profit entity, likely run by a financial institution. From a tax standpoint, contributions to the fund count as charitable contributions. After contributing to the fund, you can control how that money will be invested, to what charity/charities it will ultimately be distributed, and when those distributions will occur.
• Donor-advised funds do not provide any unique tax benefits. Any tax savings you get from contributing to a donor-advised fund could be achieved through donating directly to some other charity instead.
• Donor-advised funds do, however, provide certain administrative benefits, such as separating the tax planning decision (how much to donate in a given year) from the ultimate decision of how much to give to which charity.
• Donor-advised funds also make it easier to donate appreciated securities
• Donor-advised funds also make it easy to donate anonymously.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.