If you are a charitably minded individual, you probably donate to charities to have a positive impact on the causes that matter most to you. An added benefit to your charitable donations is that they can help reduce your tax liabilities. Wouldn’t it be great if there were a way to maximize your charitable impact while simultaneously lowering your taxes? Fortunately, there is! It is called a donor-advised fund (DAF).
What is a DAF?
A DAF is a private account that holds irrevocable charitable donations for future use. DAFs accept contributions of cash, securities and other assets. The donor of the assets is eligible for a tax deduction during the year in which he/she contributes to the account. Assets held within the account are able to grow tax-free for future use, and the donor retains flexibility to determine when, and to what charities, donations are allocated.
Benefits of a DAF
There are several advantages of using a DAF as your charitable giving vehicle. Here are a few:
- Easy to establish – The process of setting up a DAF is similar to opening other types of investment accounts, with similar paperwork requirements.
- Streamlined recordkeeping – The financial institution that holds the DAF is responsible for tracking contributions and distributions and providing simplified tax reporting. This means you have few administrative duties related to the account.
- Tax benefits – Contributions to DAFs are deductible on your itemized tax return during the year in which they are made. This makes donating to a DAF a particularly valuable strategy during years in which your income is higher than usual, as you can use the donation to offset a portion of your earnings, potentially lowering your tax exposure.
- The ability to “bunch” your donations – One particularly effective DAF contribution strategy is called “bunching.” Using this strategy, you would bunch multiple years’ worth of charitable donations into a single large contribution. Doing so allows you to maximize your tax deduction during years in which your taxable income is higher than usual.
For example, say you have a goal of contributing $8,000 per year to various charities, and you currently file a standard tax return. You are anticipating a larger-than-normal bonus payment from your job this year. You may decide to use a portion of this bonus to “bunch” four years’ worth of donations into a single donation to your DAF.
You decide to donate $32,000 in 2024, which reduces your taxable income for the year. Because your exclusions now exceed the standard filing threshold ($15,000 in 2025), it makes sense to file an itemized tax return. Doing so allows you to claim the full $32,000 as a deduction. You make your annual $8,000 donation from the DAF to the charities of your choice and maintain the remaining $24,000 in the DAF for future charitable donations.
Limitations of a DAF
In addition to the benefits of DAFs, there are some limitations to be aware of, which is why it is important to consult with your financial advisor to determine if a DAF is right for you. Limitations include:
- Irrevocable donations – The assets donated to a DAF are considered “irrevocable,” which means you are not able to withdraw them at a later date. And, although you are able to advise on how the assets are donated, the financial institution that holds the account may have limitations on how the assets can be distributed. It is important to fully understand any potential restrictions before donating to a DAF.
- Cost – DAFs typically come with administrative and investment management fees. If the assets in the account experience poor investment returns, the associated fees have the potential to erode the account’s value over time.
- Limited charitable options – The IRS requires that DAF assets be donated only to pre-approved charities, which can limit your donation options.
If you could use some help determining whether a DAF is right for you, we would love to have a conversation. To learn more about how United Capital Financial Advisors can help you support your favorite charities while potentially reducing your tax exposure, please contact us.
