What Is A Donor-Advised Fund And How Does It Work?

Donor-advised funds have become the fastest-growing philanthropic tool in the U.S. and are accessible to any charitable donor, not just the ultra-wealthy. By providing one of the most tax-efficient mechanisms for donating, donor-advised funds have opened up new opportunities for impactful philanthropy.

Although often assumed to cater exclusively to major philanthropists, donor-advised funds can benefit anyone who wants to donate to charity in a simple, strategic, and tax-advantaged way while maintaining control over how and where their contributions are granted. In this article, let’s understand what is a donor-advised Fund and what are its benefits.

What Is A Donor-Advised Fund?

A Donor Advised Fund (DAF) is a type of philanthropic fund offered by many community foundations and private foundations. Donors contribute money or assets to a donor-advised fund, and the fund allows donors to advise charities and grant recipients. For making donations, the donors are also entitled to a tax deduction. The account is managed by a sponsoring organization and it technically gains control over the assets as soon as they are deposited into a donor-advised fund. However, as long as a donor choose a charity that is recognized by the IRS as a U.S. charitable organization, the sponsoring organization will generally use their charities of choice.

Benefits Of Donor Advising Fund

In addition to providing direct financial support to charities, donor-advised funds offer several tax and financial benefits for donors. Potential advantages of a donor-advised fund include:

Establishing The Fund

Donors establish the fund by contributing money or appreciated assets like stocks, bonds, or real estate. The fund becomes an endowment, and the assets are invested to generate annual grants. Donors can name the fund and provide recommendations on the types of charities or causes they want to support.

Making Grant Recommendations

At any time, donors can recommend grants from their funds to qualified 501(c)(3) nonprofit organizations. Community foundations review the recommendations to ensure grant guidelines are met, but donors retain the ability to advise grants as long as their fund exists. Donors can recommend one-time grants or ongoing support.

Tax Management

Donors can claim a tax deduction for assets contributed to a donor-advised fund in the year of contribution rather than when grants are distributed to charities. Large contributions can produce substantial deductions. For example, a donor providing $180,000 today could deduct that amount instead of $36,000 annually for five years. The deduction potential may be larger with an upfront contribution.

Remaining Involved Or Anonymous

Some donors want to actively participate in choosing grant recipients, while others prefer to remain anonymous. Donor-advised funds accommodate both approaches. Active donors can suggest new causes and charities to support each year, while anonymous donors rely on the community foundation’s expertise.

Spending Flexibility

While assets in a donor-advised fund are invested for the long term, donors maintain flexibility in how much to spend each year on grants. They can spend anywhere from 5-100% of the fund’s available balance depending on their preferences and priorities. Unspent amounts remain in the fund to support future recommendations.

Ensuring A Lasting Legacy

Donor-advised funds provide a simple way to establish a philanthropic legacy while still actively participating in the grantmaking process. Even after a donor’s lifetime, the fund continues supporting important causes and charities in the community. With their guidance, donor-advised funds are a powerful way to make a meaningful and lasting impact.