No matter how the 2017 Tax Cuts and Jobs Act (TCJA) may alter your tax planning, we would like to believe one thing will remain the same: With or without a tax write-off, many Americans will still want to give generously to the charities of their choice. After all, financial incentives are not usually the main motivation for giving. We give to support the causes we cherish. We give because we are grateful for the good fortune we have enjoyed. We give because it elevates us too. Good giving feels great – for donor and recipient alike.
That said, a tax break can feel good too, and it may help you give more than you otherwise could. Enter the donor-advised fund (DAF) as a potential tool for continuing to give in a meaningful and tax-efficient way under the new tax law.
What Has Changed about Charitable Giving?
To be clear, the TCJA has not eliminated the charitable deduction. You can still take it when you itemize your deductions. But the law has limited or eliminated several other itemized deductions, and it has roughly doubled the standard deduction (now $12,000 for single and $24,000 for joint filers). With these changes, there will be far fewer scenarios in which it will make sense to itemize deductions instead of just taking the now-higher standard allowance.
This introduces a new incentive to consider batching-up your deductible expenses, so they can periodically “count” toward reducing your taxes due – at least in the years you have enough itemized deductions to exceed your standard deduction. For example, if you usually donate $2,500 annually to charity, you could instead donate $25,000 once each decade. Combined with other deductibles, you might then be able to take a nice tax write-off for that tax year and take the standard deduction in the other years.
“With or without a tax write-off, many Americans will still want to give generously to the charities of their choice.”
What Can a DAF Do for You?
Donor-advised funds (DAFs) are not new; they have been around since the 1930s. But they have been garnering more attention as a potentially appropriate tax-planning tool under the TCJA. Here is how they work:
- Make a sizeable donation to a DAF. Donating to a DAF, which acts like a “charitable bank,” is one way to batch up your deductions for tax-wise giving. But remember: DAF contributions are irrevocable. You cannot change your mind and later reclaim the funds.
- Deduct the full amount in the year you fund the DAF. DAFs are established by nonprofit sponsoring organizations, so your entire contribution is available for the maximum allowable deduction in the year you make it. Plus, once you have funded a DAF, the sponsor typically invests the assets, and any returns they earn are tax-free. This can give your initial donation more giving-power over time.
- Participate in granting DAF assets to your charities of choice. Over time, and as the name “donor-advised fund” suggests, you get to advise the DAF’s sponsoring organization on when to grant assets, and where those grants will go.
Thus, donating through a DAF may be preferred if you want to make a relatively sizeable donation for tax-planning or other purposes, you would like to retain a say over what happens next to those assets, and you are not yet ready to allocate all the money to your favorite causes. Along the spectrum of charitable giving choices, a DAF is relatively easy and affordable to establish, while still offering some of the benefits of other planned giving vehicles. As such, they fall somewhere between simply writing a check to the charity, versus taking on the time, costs and complexities of a charitable remainder trust, charitable lead trust, or private foundation.
How Do You Differentiate DAFs?
If you decide a DAF would be useful to you, the next step is to select an organization that sponsors a DAF. Sponsors typically fall into three categories: financial providers (such as brokerage firms), independent DAF organizations (American Endowment Foundation is one), and “single issue” entities (such as religious, educational, or emergency aid organizations).
Within and among these categories, DAFs are not entirely interchangeable. Whether you are being guided by a professional advisor or you are managing the selection process on your own, it is worth doing some due diligence before you fund a DAF. Here are some key considerations:
- Minimums – Different DAFs have different minimums for opening an account. For example, one sponsor may require $5,000 to get started, while another may have a higher threshold.
- Fees – As with any investment account, expect administration fees. Just make sure they are fair and transparent, so they do not eat up all the benefits of having a DAF.
- Acceptable Assets – Most DAFs will let you donate cash as well as stocks. Some may also accept other types of assets, such as real estate, private equity or insurance.
- Grant-Giving Policies – Some grant-giving policies are more flexible than others. For example, single-entity organizations may require that a percentage of your grants go to their cause, or only to local or certain kinds of causes. Some may be more specific than others on the minimum size and/or maximum frequency of your grant requests. Some have simplified the grant-making process through online automation; others have not.
- Investment Policies – As touched on above, your DAF assets are typically invested in the market, so they can grow tax-free over time. But some investments are far more advisable than others for building long-term giving power. How much say will you have on investment selections? If you’re already working with an advisor, it can make good sense to choose a DAF that lets your advisor manage these account assets in a prudent, fiduciary manner, according to an evidence-based investment strategy.
- Transfer and Liquidation Policies – What happens to your DAF account when you die? Some sponsors allow you to name successors if you would like to continue the account in perpetuity. Some allow you to name charitable organizations as beneficiaries. Some have a formula for distributing assets to past grant recipients. Some will roll the assets into their own endowment. Also, what if you decide you would like to transfer your DAF to a different sponsoring organization during your lifetime? Find out if the organization you have in mind permits it.
Selecting an ideal DAF sponsor for your tax planning and charitable intent usually involves a process of elimination. To narrow the field, decide which DAF features matter the most to you, and which ones may be deal breakers. Your advisor can help you make a final selection and meld it into your greater personal and financial goals.