Did you know that donor-advised funds (DAFs) provide the most flexible and tax-smart way to give? And we’re offering some tips on how to use DAFs to maximize charitable giving at the end of the year.
For those who are unfamiliar, DAFs are financial accounts that allow you to make tax-deductible contributions of cash or assets, invest the money in the account tax-free and then recommend grants out of the account to your favorite charities over time. Their flexibility is valuable. In fact, they are becoming so popular that over 10% of all charitable giving now flows through them.
New DAF providers like Charityvest are making them free and easy to use as well, further encouraging their growth.
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Because DAFs decouple the timing in which your charitable funds are tax-advantaged and when they must go to a specific working charity, there are more ways you can purposefully leverage the charitable funds in your DAF for impact.
In addition, the flexibility of DAFs makes it much easier to take advantage of the slickest tax strategies related to charitable giving. As we approach the end of the year and charitable giving starts to become more top of mind, here are six tips you can use to make your year-end giving maximally purposeful and tax-smart.
1. Give Appreciated Assets Instead of Cash.
If you are planning on giving to charity at the end of the year, this is the single most tax-smart move you can make. By contributing long-term appreciated assets like stock or mutual funds to your DAF, you can avoid paying capital gains taxes on the growth. The DAF then sells the asset and puts the proceeds in your DAF, and you get a tax deduction for the full market value of the asset.
You can multiply your bonus — you avoid capital gains tax and get an income tax deduction.
If you have illiquid assets such as real estate or private business interests, you can also consider giving those, or a portion of them.
DAFs are experienced in taking in assets, unlike working charities, so it's usually prudent to give assets to a DAF instead of adding complexity to charities and their teams.
2. Consider How You Can Use Your DAF's Flexibility to Be More Strategic.
It's easy to stick to the patterns of how we've funded charities in the past — fundraisers, recurring support, year-end gifts, etc.
Think "blue sky" about the kind of long-term impact you'd like to have and structure your grant timing around that as much as you feel comfortable. For example, if you want to show support to a charitable leader you believe in, perhaps monthly recurring support is right. But if you'd like to provide strategic capital for recovery after the next emerging world disaster, perhaps storing up some charitable resources in your account is particularly strategic.
3. Bunch Up Your Charitable Deductions.
By making larger, less frequent gifts to your DAF, you can itemize your deductions on your tax return in years when you have higher income or deductions from other sources. This is especially beneficial in years where you may not itemize otherwise due to the new higher standard deduction.
4. Consider Impact Investments.
Most people are reluctant to commit money to charitable purposes because of the limitations of what can be done with that capital going forward, especially with how it can continue to grow.
Many DAFs enable impact investments with capital sitting inside them. Impact investments can be equity investments in technology for good companies, real estate or public sanitation and agricultural projects. As a result, you can get excellent returns on your investment while also making a difference.
5. Consider Involving Your DAF in Your Estate Planning and Discuss Your Charitable Legacy.
Any assets you commit to a DAF are no longer a part of your legal estate and thus not subject to estate taxes. If you are charitably inclined and have a taxable estate, this can be a powerful way to minimize your estate taxes. Planning for your estate also contributes to your comprehensive legacy, which should include giving.
In addition, you can also name your DAF as a beneficiary in your will or trust. This has the same effect as making a bequest to charity, but with the added benefit that your assets can continue to grow in the DAF until they are paid out to charity.
6. Pace Your Contributions to Match Your Income.
Many people have variable income. By increasing your DAF contributions in years when your income is higher, you can minimize your overall tax responsibility.
For example, if you think you will be in a lower tax bracket this year but in a higher bracket next year, you can contribute to your DAF less this year and more next to maximize the tax savings of each marginal dollar you contribute. With a DAF, you can throttle up or throttle down your contributions to be tax-optimized while making your grants to charities smoother.
If you follow these tips on how to leverage your DAF, you can make your year-end giving maximally purposeful and tax-efficient. The more thoughtful and intentional you are about giving, the more you'll give. As giving has been shown to be addictive, before long, you just might find yourself living a more generous life.
Lastly, consider opening a DAF if you haven't already. DAFs are an excellent way to make the most of your year-end giving.
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