Donor-advised funds can maximize the tax benefits of your charitable giving.
Here is a step-by-step look at how donor-advised funds work:
- Make tax-deductible contributions to a donor-advised fund
- Invest contributions in short-term and long-term assets
- Contributions grow tax-free (income tax and capital gains tax)
- Make charitable grants to eligible charities out of the fund
Contributions to a donor-advised fund can qualify for an upfront tax deduction when you file an itemized return. Instead of writing a check or donating physical assets to a qualifying charity, the cash contribution comes from the donor-advised fund.
It’s possible to make charitable grants in the same year you contribute to a donor-advised fund. You can also distribute your cash over a period of several years. You may pursue this strategy to maximize your tax deductions for the current tax year.
Donor-advised fund contributions won’t help your tax situation if you claim the standard deduction and file a non-itemized return. So many people use these funds to contribute large donations in one year so they can itemize, then dole the money out over the next few years.
For example, if you normally donate $500 a month to your church the $6,000 in additional deductions might not be enough to put you over the standard deduction.
However, if you bunch several years together and contribute $18,000 to your donor-advised fund this year you’ll be able to itemize, and then send $500 per month to your church out of your donor-advised fund for the next three years.
Same money out of pocket over the three years and the church still gets their $500 a month as usual. The only difference is that you get a tax deduction you wouldn’t have otherwise received.
Table of Contents
- Who Can Open a Donor-Advised Fund?
- Annual Account Fees
- Account Minimums
- Qualified Contributions
- Potential Tax Benefits
- Tax-Deductible Contributions
- Contributions Grow Tax-Free
- Lower Estate Taxes
- Investment Options
- Qualifying Charitable Grants
- Do Donor-Advised Funds Have a Spend Rule?
- Pros & Cons of Donor Advised Funds
- Are Donor-Advised Funds Worth It?
- Best Donor-Advised Funds
Who Can Open a Donor-Advised Fund?
The following parties can open a donor-advised fund:
Any adult taxpayer at least age 18 can open a donor-advised fund. But you must file an itemized tax return to qualify for the tax-deductible contributions to a donor-advised fund.
For tax year 2021, individual filers can “itemize” with $12,550 and joint filers qualify with $25,100 in qualifying deductions.
Charitable contributions, medical expenses, mortgage interest and state or local property taxes can qualify for itemized deductions. A donor-advised fund maximizes your charity donations.
Non-itemizers should donate directly to their favorite charities as a donor-advised fund won’t help their tax situation.
Learn more about the difference between tax credits and tax deductions.
Annual Account Fees
There are ongoing fees for the recordkeeping and fund management conveniences.
Most plans charge an annual management fee of either 0.60% or $100, whichever is greater. Other incidental fees may apply as well for certain services.
There are also the annual investment fees that stock, bond and fixed income funds charge. These annual expense ratios are usually between 0.03% and 1.00%. The investment fees are the same as if you buy the same funds in a taxable brokerage account.
There can be an initial deposit requirement. Both Fidelity Charitable and Schwab Charitable require a $0 initial deposit. But some providers may require an opening contribution between $5,000 and $25,000. Subsequent donations may have a $0 minimum.
For hands-on financial advisor management, the minimum account balance may need to be as high as $250,000.
There can also be a minimum charitable grant requirement of at least $50 per donation. This donation minimum offsets the labor and time necessary for the fund provider to send a charitable grant.
There are several ways to contribute to a donor-advised fund:
- Mutual fund shares
- Privately-held business interests (i.e., pre-IPO shares, C-Corp stock, private equity)
- Restricted stock
- Oil and gas interests
- Life insurance
- IRA and 401(k) retirement accounts
- Bitcoin and other cryptocurrencies
Contributions up to 60% of the annual adjusted gross income can be tax-deductible. Each donor-advised fund contribution is irrevocable and cannot be “reversed.”
In addition to donating assets you already have on hand, donor-advised funds can be a beneficiary for retirement accounts.
Potential Tax Benefits
There are immediate and ongoing tax benefits that tax filers will enjoy.
The upfront tax deduction for qualifying contributions reduces the taxable income for the contribution year.
Under the current IRS tax rules, taxpayers can deduct charitable contributions (up to 60% of the adjusted gross income) when filing an itemized tax return. All donations made on or before December 31 can qualify for a tax deduction.
In addition to the instant tax deduction, donor-advised funds can make recordkeeping easier. You don’t have to track each donation receipt as the fund does instead. When you file your taxes, you only have to report your annual donor-advised fund contribution amount.
Contributions Grow Tax-Free
The compound interest grows tax-free like a Roth IRA for all donor-advised funds contributions. No investment is risk-free and your long-term investments can lose value when you’re ready to request a charitable grant.
Lower Estate Taxes
Households forming their estate planning strategy may reduce their estate tax by contributing to a donor-advised fund.
Speaking with a tax professional can be the best option to calculate the potential long-term tax benefits of donor-advised funds.
Many donor-advised funds have multiple investment options to earn tax-free passive income and boost your charitable grant amount. It’s possible to invest in short-term assets like money market funds and long-term assets like stock index funds.
Investment options may include:
- Stock and bond index fund portfolios
- Actively-managed fund pools
- Socially responsible investing pools
- Money market funds
How often you withdraw from the donor-advised fund and make charitable grants can determine your investment strategy.
For example, if you decide to make a one-time contribution in January and donate through the year, the contributions may go into a low-risk money market fund.
But cash that you plan on donating several years (or decades) down the road may invest in a stock index fund portfolio.
Learn more: Best low-risk investments
Qualifying Charitable Grants
You can use donor-advised funds for most IRS-qualified 501(c)(3) public charities that accept tax-deductible gifts.
Some of the qualifying charity types include:
- Local churches and religious organizations
- Homeless shelters
- Food pantries
- Medical research
- Alumni associations
- Educational organizations
- Arts councils
- International aid
The fund administration team verifies your designated charity qualifies for donor-advised funds before sending a grant.
Charities can receive grants by check or electronic funds transfer (EFT).
It’s also possible to make anonymous donations and designate grants for a specific purpose.
Non-Qualifying Charitable Grants
Some donation types are ineligible for donor-advised fund grants:
- Private charities and foundations
- Non-operating charities
- Political candidates and parties
Donations that result in personal benefit do not qualify either. For example, grants cannot cover membership dues, tuition and fees, buy items at a charity auction, or travel costs related to attending a charity event.
Once you put money into a donor-advised fund you can’t get it back – the donation is irrevocable.
Think of it as giving $500 to your church, taking the tax deduction, and then asking for the money back. Can’t do it.
Therefore, take contributing to this fund very seriously.
Do Donor-Advised Funds Have a Spend Rule?
The IRS doesn’t have minimum required distribution rules for donor-advised funds.
However, the donor-advised fund provider may require periodic contributions or withdrawals to keep the account active. The “spend rule” varies by provider.
You may need to show account activity at least once per year, for instance. If the account becomes inactive, the provider may transfer the undesignated funds into their corporate charitable trust.
Before assuming the funds, the provider will contact the account holder and listed successors to keep the account active.
It’s also important to verify the provider’s succession rules. In many cases, a donor-advised fund can exist “in perpetuity” when the account holder designates successors. There can be multiple successors. The successor may need to be at least 18 years old before they can recommend making charitable grants.
Pros & Cons of Donor Advised Funds
- Tax-deductible contributions
- Investments grow tax-free
- Can make charitable grants in future years
- Donate to IRS-approved public charities
- Individuals, families and organizations can qualify
- Must “itemize” to qualify for tax benefits
- Annual management fees
- Not every charity qualifies for grants
- Contributions are irrevocable
Are Donor-Advised Funds Worth It?
If you like to support multiple charities or make recurring donations, a donor-advised fund can make recordkeeping simple and may maximize your tax deductions.
Also, the fund sponsor ensures each contribution goes to a legit charity which can make performing due diligence less burdensome.
However, you must be able to file an itemized return to capture the tax benefits of a donor-advised fund. One must also decide if the annual management fees are worth the convenience and tax benefits.
Best Donor-Advised Funds
There are several places to open a donor-advised fund. Here are some of the places to consider first due to their low account minimums and flexible investment options.
Fidelity Charitable is part of the Fidelity Investments family. And you don’t need a Fidelity brokerage account to qualify. There isn’t an account minimum. The annual administrative fee is either $100 or 0.6%, whichever is greater.
Schwab Charitable is similar to Fidelity Charitable and can be a good option if you invest or bank with Charles Schwab. A “core account” donor-advised fund has no account minimum.
The annual administrative fee is $100 or 0.60% of the first $500,000, whichever is greater. The fee decreases as the balance amount increases.
Having a $250,000 account balance qualifies for a professionally-managed account.
“Bogleheads” may appreciate Vanguard Charitable though the account minimums are higher than other providers. The minimum initial deposit is $25,000 and subsequent contributions must be at least $5,000. Also, charitable grants must be at least $500 while Fidelity and Schwab only have a $50 withdrawal minimum.
There are several risk-based asset allocations and values-driven investment portfolios that invest with Vanguard funds.
National Philanthropic Trust
A minimum initial deposit of $10,000 opens a fund with National Philanthropic Trust. The account balance invests into an impact investing fund until you request a charitable grant. Fees vary by account size and services.
Donor-advised funds are an easy way to maximize the tax benefits of charitable giving and it’s possible to support multiple charitable causes right now and in the future.
Just keep in mind that once you contribute to a donor-advised fund you can’t take the money back out. Those contributions are as irrevocable as if you donated directly to a charity.