Establishing a Donor Advised Fund

A donor advised fund is, in effect, a charitable savings account. A donor advised fund permits an individual donor to make a donation without choosing a specific charity at the time the gift. The transfer of cash or assets to the donor advised fund sponsor permits the donor to claim an immediate income tax charitable deduction.

Donor advised funds are increasingly popular as a form of charitable giving. The number of donor advised funds increased by 64% from 2017 to 2018. The amount of assets held in donor advised funds across the nation increased from $110 billion to $121 billion from 2017 to 2018. Gifts from donor advised funds exceeded 12% of all charitable giving in 2018.

Donor advised funds are popular for several reasons. A donor advised fund is both easy and inexpensive to open and manage. Charitable gifts from the fund can be anonymous. The fund can accept non-cash gifts like securities, partnership interests and other assets that a smaller charity might be unwilling to accept. Family values can be perpetuated with younger family members participating in the selection of charities to receive distributions from the fund, even after the individual who established the fund dies. In addition, the donor’s record-keeping is greatly simplified with no need to retain receipts and letters from the charities to which grants from the fund are made.

With the doubling of a taxpayer’s standard deduction with the 2017 Tax Act, a donor advised fund can receive a large transfer of assets in one year that enables the donor to itemize her tax deductions and claim a charitable income tax deduction. Practically speaking, most Americans do not gain any benefit with a charitable income tax deduction in light of the doubled standard deduction. A large gift to a donor advised fund permits an individual donor to bunch a large charitable gift to a donor advised fund in one calendar year, claim an itemized charitable income tax deduction, and then use the donor advised fund to make charitable gifts in several following tax years when claiming the standard deduction on their income tax return.

A donor advised fund (the fund) is simple to open. The donor makes an irrevocable gift to the fund’s sponsoring charity. The donor receives an immediate charitable income tax deduction. The charity liquidates the contribution without any taxation. All growth in the fund’s post-liquidation investments is tax-free. The charity holds the gift in a segregated account on its books. The donor holds “advisory capabilities” over the fund and requests that grants be made from that fund to charities of the donor’s choice. The sponsoring charity holds what is called a variance power, rarely exercised, that gives it the authority to reject the donor’s request. The variance power is critical to ensure the fund sponsor’s independence, and from that, the donor’s charitable income tax deduction. Normally the variance power is exercised if the proposed recipient of a grant is not an organization that is recognized as tax exempt by the IRS or if the proposed recipient has a mission that is contrary to that of the fund sponsor.

However, because there are so few rules that govern donor advised funds each sponsor’s fund is different. Consequently, choosing where to establish a donor advised fund (the fund) requires a bit of study. Unfortunately, there is no central resource that evaluates donor advised fund sponsors. Several questions need to be asked of a fund sponsor before entering into a Donor Agreement. Those questions might include the following:

• Can grants from the fund be made anonymously?
• Can younger family members be named as successor advisors to the fund?
• Is there a maximum duration that the fund can be maintained?
• If there is a maximum fund duration, what happens to the remaining investments in the fund when that maximum duration is reached?
• Is there a minimum grant (amount or number) required from the fund each year?
• Is there a minimum amount required to establish and maintain the fund?
• How frequent is the reporting from the sponsor to the donor about the fund?
• What investment options are available for the fund?
• What annual investment and management fees are charged to the fund?
• Are there some types of assets that the fund sponsor will refuse to take as a contribution?
• Can the donor use her own financial advisor to manage the investments?
• Are restrictions permitted on when fund contributions will be liquidated?
• Does the sponsor offer a socially responsible investment option?
• Does the sponsor have expertise regarding charities and community needs?
• Does the sponsor provide any additional services or guidance to the donor?

Ultimately, the choice of fund sponsor is one that the donor is comfortable with, either because of its flexibility, its fee, its locale, or its link to causes or missions close to the donor’s.

While donor advised funds are rapidly gaining in popularity, they are not without their critics. Currently, there is no government regulation that requires the assets held in a fund to be distributed to a charity within a specified period. Arguably, the donor could contribute substantial assets to a fund, claim a current income tax charitable deduction, yet let the fund sit indefinitely, growing tax-free. While that is possible, most donors wish to see an impact from their gifts as soon as possible. Some in Congress now want to take a second-look at the “warehousing” of charitable dollars in donor advised funds, so there could be some regulations on the horizon that require annual grants of a certain size, e.g. 5% of the fund balance, each year.

It should also be noted that a donor advised fund is not a permissible charity if the donor wishes to make a qualified charitable distribution from her traditional IRA in satisfaction of her required minimum distribution (RMD) for a year.

Even when we experience wild market adjustments, as in March of this year, a donor advised fund acts as something of a buffer, where donors can continue to give to charities and make a difference in their communities even when their own personal investments have lost value. Anecdotally, donor advised funds have been a tremendous source of support to communities and to charities this past spring as the nation reeled from the COVID-19 pandemic.

Philanthropy is dramatically changing with the advent of donor advised funds. If interested in this relatively new approach to charitable giving, hopefully you will be able to find a donor advised fund sponsor that meets your needs to implement an organized and efficient charitable giving plan.