When to consider a donor-advised fund

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By Evan T. Beach, CFP
Posted on November 14, 2024

Too often we think about charitable giving in the context of the rich and powerful, where, it seems, the rich keep getting richer via some complex charitable strategy.

While there are significant tax benefits to properly structured charitable giving, the reality is much less exciting. You will save some percentage of your gift if you do it properly, but you’ll always end up with less money than you started with. That’s the point: You’re giving money away.

When it comes to charitable planning, charitable intent must be the first box you check. Once you have decided you can afford to give and that you want to give, you have to decide how you’ll give.

A donor-advised fund (DAF) may be that “how.” Put simply, a DAF is a financial account that allows you to make tax-deductible contributions of cash or assets, invest those contributions now in the account tax-free, and then recommend grants out of the account to your favorite charities over time.

Your tax deduction is recognized at the time you put the money into the DAF, regardless of when the money makes it to your charity of choice.

Below are three triggers that you can use as a hand-raising exercise. If you are charitably inclined and raise your hand to one or more of these triggers, you should evaluate a DAF. I have also used this strategy for many clients who are not in these situations, so this is by no means a comprehensive list.

You no longer itemize

In 2018, the Tax Cuts and Jobs Act (TCJA) significantly changed the tax code. The Tax Foundation estimates that only a third of taxpayers who itemized pre-TCJA itemize post-TCJA.

In plain English, a very small percentage of taxpayers will actually be able to take a charitable deduction for their giving because they do not give more than the standard deduction.

This reality introduced a strategy called “charitable stacking,” where instead of giving every year, you give charity for many years all at once.

For example, instead of giving $10,000 per year over five years, you give $50,000 in one year and then don’t give for the subsequent four years. This allows you to get above the standard deduction in year one and receive a tax benefit for your giving.

The handy part of the DAF in this scenario is that this doesn’t have to disrupt the beneficiaries of your giving. You can make the donation into the DAF in year one and then make grants from that fund in future years, just as you would have if the funds were coming from your bank account.

You sold your forever home

We live in the DC Metro area. It seems like in the past five years, every home purchased by a Boomer in the ’80s or ’90s is now worth over $1 million. This is an uptown problem for the owner, but it likely makes a portion of the gain from a sale taxable from the IRS perspective.

Depending on the size of the gain and where you live, that can be substantial. A $500,000 gain in Maryland is likely to cost you $150,000 in federal and state taxes.

On the plus side: Charitable giving has a bigger impact [Ed. Note: offsetting other income] in years when your tax rates are especially high. Because the sale of a home is a one-time hit, your tax rate will be higher that year but drop the following year.

So we often advise clients to make several years of charitable gifts in the year they sell their home. They can then distribute those funds in future years from their DAF as they would have under normal circumstances.

You just retired or sold your business

The typical tax trend for those who retire is down, then up. Once wages go away, but before you claim Social Security and take distributions from retirement accounts, your effective tax rate should be lower. Charitable contributions will be less impactful during this period, as they offset a lower obligation.

On the flip side, your last year working is often the one with the highest income and, therefore, the highest tax rate. This is compounded if you are a business owner who has just sold a business.

A DAF will allow you to make large charitable contributions in that final year of work (or sale) and take that deduction against a larger amount of gross income without having to decide who you are giving to. You can make that decision in subsequent years when grants are made from the fund to the charities of your choice.