What Are Donor-Advised Funds? How DAFs Work

Here's how donor-advised funds might help you cut your tax bill and give back to the community.

Tina OremOctober 21, 2020
What Are Donor-Advised Funds? How DAFs Work

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What are donor-advised funds?

A donor-advised fund, or DAF, is an account into which you deposit assets for donation to charity over time. You, the donor, get a tax deduction for depositing assets in the fund. A sponsoring organization manages the account; you recommend how to invest and where to donate the assets.

Who qualifies for a donor-advised fund

You don’t have to be wealthy to get into a DAF; some have minimum contributions of $5,000.

You can contribute different kinds of assets to a DAF, such as:

  • Cash.

  • Stocks, bonds and mutual fund shares.

  • Money in IRAs and 401(k)s.

  • Private company stock.

  • Cryptocurrencies.

  • Life insurance.

Tax benefits of donor-advised funds

  • A tax deduction. You can claim a tax deduction in the year you contribute assets to the DAF rather than in the year the contribution goes to the charity. For example, if you typically donate $100 a month to charity ($1,200 a year), you could essentially prepay for, say, five years’ worth of donations by putting $6,000 in a DAF now. The DAF would use the money to disburse $100 a month to the charity as usual, but you would get a $6,000 tax deduction this year instead of a $1,200 deduction every year for the next five years. Getting a giant deduction in one year could be worth more than a smaller $1,200 deduction every year for the next five years.

  • Helps avoid capital gains tax. You won’t pay capital gains tax on assets that you put in a donor-advised fund, and if you donate assets that are worth more than what you paid for them, you typically can deduct the current market value of the asset rather than what you originally paid for the asset.

  • Possibly lower estate tax. Few people have to pay estate taxes, but if you’re one of those few, putting money in a DAF can reduce the size of your taxable estate.

How to invest in a DAF

Here's how to do it.

1. Find a donor-advised fund. There are many different kinds of sponsoring organizations. Commercial donor-advised funds, for example, are run by nonprofit arms of national financial-services firms. We highlight three of them in the table below.

2. Contribute cash or other assets to the donor-advised fund. You can put in cash, stocks or other investments, such as cryptocurrency or even your ownership in a private business. Note: Contributions are irrevocable, meaning that once you contribute the assets, you can’t get them out again.

3. Claim your tax deduction. You’ll need to itemize your taxes to get the tax break. That means filling out Schedule A when you do your taxes and making sure that your itemized deductions exceed the standard deduction to get the most bang for your donated bucks. (Learn more about deciding whether it's worth it to itemize on your taxes this year.)

4. Help your donation grow. The assets in a DAF can be invested until they’re ready to be donated to the charity. Although the sponsoring organization controls the money in the DAF and the investment options you choose from, you get to recommend which investments to use.

5. Give it away. That’s the goal of the entire process. You can support pretty much any IRS-qualified public charity. Typically, the entity that sponsors the DAF is responsible for checking out charities to ensure that the money goes to a legit one.

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