Donor-Advised Funds: A Tax-Advantaged Way to Give

In my last few blogs, I discussed some tax-advantaged financial strategies that typically fly under the radar and how clients can use them to their advantage. When it comes to charitable giving, there’s another tax-saving strategy you should know about: donor-advised funds.

A donor-advised fund, or DAF, is essentially a charitable investment account. You can contribute money or other assets into the account, receive a tax deduction the year you contribute, grow the money within the account, and then distribute the funds to charity over time.

This strategy can be beneficial for a few reasons:

Mitigate taxes during a high-income year

Contributing to a donor-advised fund allows you to receive a significant tax deduction during a year that could otherwise become a major tax burden. Maybe you sold a business or rental property, received severance pay, want to exercise stock options, or had a great year for some other reason. Instead of dispersing charitable donations over the next 10 or 20 years, you can contribute a lump sum to a DAF during that high-income year, receive the deduction upfront, and then distribute the money to charities of your choice over time.

This allows you to soften the blow from the large taxable event while meeting your philanthropic goals.

Avoid Capital Gains Taxes

Donor-advised funds allow you to contribute different types of assets, including appreciated stock. This can be especially beneficial if you have stocks that have grown significantly since you acquired them, whether through employer stock options or personal investments. 

Let’s say you invested $10,000 in Apple years ago, and now it’s worth $100,000. If you contribute this stock to a donor-advised fund, you get to take a $100,000 deduction and give all the money to charity. Almost every other scenario where you liquidate or diversify that stock would trigger a capital gains tax on the $90,000 growth, meaning you could lose out on $18,000 to taxes.

Depending on the custodian, other qualifying assets might include bonds, mutual fund shares, private or restricted stock, cash equivalents, and even cryptocurrency^[1].

Take Advantage of Itemized Deductions

For some clients with high income, DAFs make it easier to take advantage of itemized deductions.

Currently, the standard deduction is $32,200 for married couples filing jointly (and half that for single filers), so even if you donate a significant amount each year—say, $20,000 as a couple—it doesn’t make sense to take itemized deductions, given that the standard deduction is higher.

However, if you combine your planned charitable giving for several years into one contribution to a donor-advised fund, you can take the itemized deduction that year, and the standard deduction the next. For example, if your annual giving goal is $20,000, you could contribute $40,000 to a DAF in one year, take the itemized deduction, and then take the standard deduction the following year while continuing to give $20,000 annually from the fund.

Increase Your impact

Another great thing about donor-advised funds is that they allow you to invest your contributions, so your money grows over time and creates an even greater impact. As the account grows over time, it can increase the total amount available for charitable giving.

Protect Your Retirement Income

Donor-advised funds are a great way to budget for charitable contributions during retirement. You can set aside the money while you work, receive the tax deduction during your high-earning years, and distribute the money later. This is especially helpful because it allows you to continue giving during retirement without disrupting your cash flow.

Timing Matters

The key to leveraging a donor-advised fund strategically is timing. If you’re anticipating a high-earning year—whether from a sale, severance payment, or other reason—you need to make your contribution(s) before the end of that tax year. Once the year is over, you’ll have missed your opportunity to save in taxes when you needed it most.

Timing is also important when contributing appreciated stocks, since they’ll have the most impact when donated at a high value. Of course, no one can predict exactly when a stock will be at its peak, but you can track its growth and make your best guess. Another option is to donate the stock in increments, so if it performs well in the first quarter and you donate a portion, you still have an opportunity to donate more if it performs even better in the third quarter. 

As with most financial strategies, it’s best to plan ahead.

“Is a donor-advised fund right for me?”

Donor-advised funds offer valuable opportunities for people who are already charitably inclined and need to offset a high-income year for tax purposes. They’re also great if you want to increase your charitable impact over time. But as with any financial strategy, it’s important to consider how a donor-advised fund aligns with your unique situation, goals, and needs. If you have questions or think a DAF might be right for you, I’d be happy to discuss it with you and help you identify the best path forward.