If you’re an investor looking to contribute to a charity, you might want to consider utilizing a donor-advised fund. These funds offer a straightforward and effective way for many investors to support charitable causes, but not everyone comprehends their intricacies. This lack of understanding can lead to costly errors. In this article, we’ll delve into how donor-advised funds operate and how to avoid potential pitfalls.
What Is a Donor-Advised Fund? The fundamental concept behind donor-advised funds is rather simple. As the donor, you make a tax-deductible contribution to the fund. It’s important to note that the tax deduction occurs when you contribute to the fund, not when the charity eventually receives the donation. This setup allows the donated money to be invested and grow tax-free.
The significant advantage of these funds is that they permit you to donate to your chosen charity at a later time. What’s even better is that when you donate appreciated equities, no one is subject to capital gains taxes. This enables donors to make a more substantial impact and leverage their capacity for charitable contributions over time.
Another noteworthy benefit of donor-advised funds is that contributions to these funds themselves are deductible to a maximum of 50% of adjusted gross income, in contrast to the 30% limit imposed on contributions to certain private foundations. Even more convenient, the fund managers handle the paperwork and administrative tasks, relieving donors of some of the administrative burdens.
However, it’s important to be aware that these funds are not without their challenges. They do charge fees, and the performance of investments in their portfolios is not guaranteed.
Common Pitfalls and Misconceptions Here are some frequent pitfalls and misunderstandings related to donor-advised funds:
- No Second Deductions with Donor-Advised Funds: A common misconception is that a second tax deduction is available when your charity receives a distribution from the fund. Regrettably, there is no second tax deduction; the tax benefit stems from your initial donation to the fund. Additionally, it’s crucial to recognize that the amount you contribute to the fund and the amount disbursed to a charity can differ due to market fluctuations, which can be confusing if you’re not informed. Furthermore, once you donate the money to the fund, you cannot reclaim it; it is considered donated and is no longer under your control.
- Your Charity May Not Be Approved for a Donor-Advised Fund: Don’t automatically assume that your chosen fund will allow donations to any charity. These funds must approve a charity before transferring any money. While larger charities like universities are likely to be approved, smaller charities might not be on the fund’s approved list. It’s essential to confirm that your intended charities are sanctioned by the donor-advised fund before making a donation. If the smaller charities are not approved, you can request that the fund’s managers add them to the approved list.
- No Goods or Services for Donating to a Fund: One common mistake made by financial planners is when clients anticipate receiving something in exchange for their charitable contributions. Donor-advised funds stipulate that donations are made with the understanding that no goods or services have been received in return for the gift. Attempting to use the donated money to acquire a vacation rental or any other form of compensation is not permissible.
- Unused Funds Go to Waste If They Don’t Support Charities: Avoid creating a donor-advised fund without genuine charitable intent, as the assets will remain dormant within the fund, not benefiting any charity. Some individuals establish these funds to offset a taxable windfall, resulting in funds lying idle each year due to a lack of strategic charitable-giving planning. Ensure you formulate strategic giving plans or invest the money profitably until you’ve established a clear charitable-giving strategy.
Where to Open a Donor-Advised Fund Both Vanguard and Fidelity offer reputable charitable giving funds. They provide a range of investment options with minimal fees. Fidelity distinguishes itself by enabling grants as low as $50. It’s important to note that there is an additional expense ratio of 0.6%, comparable to the tax implications seen in a taxable account. For example, a 2% dividend taxed at 30% equates to 0.6%.
Exercise Caution with Your Budget While donor-advised funds can help you maximize your charitable deductions in specific years, be cautious not to overestimate your ability to be generous. It’s vital to avoid any potential financial strain. Remember that all funds placed in donor-advised accounts are irrevocable.
