Donor Advised Funds
Donor advised charitable funds are a potentially tax-efficient means of donating money to charities. The basic mechanism operates as follows:
You make a direct contribution of cash, securities or deferred gifts to a donor advised fund which will be operated by an institution such as Vanguard. The contribution to the fund is irrevocable.
You will receive an immediate tax deduction (subject to limits on charitable deductions).
The contributions will be deposited into a fund of your choosing which will hopefully appreciate over time. The appreciation of these funds occur tax-free.
When you would like to donate some of the funds to a charity (which must be a 501( c )(a) organization), you submit a request to the institution with the amount that you would like to donate and the information of the charity. As long as the charity is properly registered, your recommendation should be accepted and the funds will be donated to the charity.
Benefits of Donor Advised Charitable Contributions
The major benefit of the donor advised fund method of making charitable contributions is that you can avoid paying capital gains tax on the securities that you plan to contribute. When you donate securities (that hold some long term capital gain tax liability) to the fund, these securities will be liquidated immediately but the fund will not need to pay any capital gains tax. You won’t be held liable for the capital gains tax either.
Additionally, you will receive the tax benefit of making a charitable contribution at the time you make the contribution to the fund (instead of when the money is actually directed to a charity). If, for some reason, you would benefit from having a tax deduction for a large charitable contribution this year (instead of future years where you might not have as large a tax liability to write off) then you can contribute money to the fund and actually make donations to your charities in subsequent years. While the money is held at the fund waiting to be donated, you can choose to have it invested in a fund with a profile matching your preferences. For instance, you can choose a conservative bond fund or deploy some portion of the money into an all-stock fund.
Finally, the donor advised fund allows you to grow money that you plan to donate to a charity in the future in a tax-free way. Any money that is contributed to the fund will appreciate (if the fund appreciates) without paying taxes on dividends or capital gains. Thus, you may be able to gain 1-2% of alpha on money that you would like to contribute in the future.
Tax Efficiency Example
The following example is taken from Vanguard’s marketing material for their plan:
Suppose you have 1,000 shares of stock that you purchased 15 years ago (thus, you’re in long term capital gains territory). Assume that you purchased the stock for $10 per share and it is now worth $100 per share. Now, let’s compare the cost to the donor of making a contribution of $100,000 to a charity of your choice.
Option 1: Contribute cash from sale of securities
Immediate cost of donation: $100,000
Capital gains tax incurred: $13,500 (15% times $100k minus $10k)
Income tax saved: ($35,000) (35% times $100k)
Net cost to donor: $78,500
Option 2: Contribute appreciated securities to donor advised fund
Immediate cost of donation: $100,000
Capital gains tax incurred: NA (15% times $100k minus $10k)
Income tax saved: ($35,000) (35% times $100k)
Net cost to donor: $65,000
Thus, you can effectively contribute $100,000 to the public charity of your choice for $13,500 less in actual donor cost by using the donor advised fund.
Caveats
Minimums – many donor advised funds have minimum initial deposits and deposits. Currently, Vanguard has a minimum of $25,000 for your initial deposit and an account balances minimum of $5,000. Fidelity’s program might have lower minimums.
Relationship with funded charities – there must be no exchange of cash or services between the individual and the charity where contributions are made.
All charities must be 501c(a) organizations – so, foreign charities are not eligible.
Technically, the fund has control of your money and can reject your donation proposals. This seems to rarely occur (only in cases where the selected charity has lost its 501c(a) status).
Key Issues
Short term capital gains – When you hold a security for less than a year that you donate to a public charity, your personal deduction will be limited to either the cost basis or the current market value of the security, whichever is lower. You can still avoid the payment of the capital gain on this security by donating it to a donor advised fund but you will not receive the full tax deduction of the security if it has appreciated. With securities held for more than one year, you can earn a tax deduction equal to the market value of the security (subject to standard limits for charitable contributions).
More Information
Vanguard Charitable Endowment Program
FPA Journal – a good overview of donor-advised funds