The Tax Cuts and Jobs Act of 2017 doubled the standard deduction.
However, the higher standard deductions now make it harder to itemize deductions.
One of the major itemizable deductions is the charitable contributions deduction.
If you used to itemize your deductions but can no longer do so, you no longer get a deduction for your charitable contributions.
Thankfully, there is a workaround that may help you get back some of your deductions. It’s called a donor-advised fund.
It’s one of the fastest-growing ways to give in the United States.
These funds take careful planning and strategy to make them work if you don’t normally itemize your deductions now.
Even if it does work in your situation, your deduction may not be as large as it used to be.
Here’s what you need to know about.
What Is a Donor-Advised Fund?
A donor-advised fund is one of many ways to make charitable contributions. You open a donor-advised fund account at a charitable 501(c)(3) organization -- available at various big-name brokerages.
Once your account is open, you donate assets to the donor-advised fund.
As long as your contributions qualify, you get a tax deduction immediately, assuming you qualify for one.
You can then invest the assets and let them grow so you can make larger charitable donations in the future.
You can make donations from the fund at any time to charitable organizations as long as they adhere to the restrictions on the account you set up.
How Do They Work?
While it sounds like donor-advised funds would be complicated, organizations like Vanguard Charitable make them much easier to manage.
You can typically contribute cash and may be able to contribute the following types of assets to a donor-advised fund.
- Mutual funds
- Private company stock in C-Corps and S-Corps
- Limited Liability Company and Limited Liability Partnership (LLP) interests
- Private equity
- Hedge fund interests
- Pre-IPO stock shares
- Restricted stock
- Life insurance
- Cryptocurrency such as Bitcoin
- Retirement assets
- Royalty interests in gas and oil
- Real estate
Always check with your preferred donor-advised fund provider or tax professional to verify any restrictions that may apply before you donate.
Once the money or other assets are in the donor-advised fund, you can let them grow.
If you contribute cash, you can invest that cash.
The best part:
Due to the power of compounding returns, the money you contribute could grow to a very large balance over decades.
When you’re ready, you can recommend grants to the company managing your donor-advised fund. This is the way to distribute money from your donor-advised fund to a public charity.
Most of your favorite charities should qualify as long as they’re 501(c)(3) charities.
Benefits of Using Donor-Advised Funds
Making contributions to a donor-advised fund has some potentially great benefits if they work for your situation.
The major benefit is the tax advantages donor-advised funds offer.
Structure donations for a tax deduction
These funds allow a workaround to help you get a charitable contribution tax deduction.
They allow you to make charitable contributions all in one year to get the maximum tax benefit.
You can continue to let the funds grow or hand the money out to charities over time.
For example, let’s say you contribute $5,000 per year to charity. Due to the new tax law, your contributions aren’t tax-deductible because you don’t itemize.
Instead of contributing $5,000 per year, you can save up your contributions.
After ten years, you could contribute $50,000 to a donor-advised fund all in the same year. This allows you to get at least some tax deduction for the amount that exceeds the standard deduction.
The other way you can get a tax deduction is to make all of your actual contributions in one year to the organizations you choose rather than to a donor-advised fund.
The benefit of a donor-advised fund is you get the tax deduction upfront but you can give regularly to charities over several years in the future rather than all in one year.
Avoid capital gains taxes
You may be able to avoid capital gains taxes on assets you donate, too.
This can save you a decent amount of money if you have assets that have appreciated significantly since you bought them.
In general, long-term appreciated assets can be donated up to 30% of your adjusted gross income (AGI). Long-term means the assets were held for over a year.
The deduction you get to claim is based on the fair market value. That means you get a bigger deduction for assets that appreciated and you don’t have to pay capital gains taxes, either.
You must follow the rules the Internal Revenue Service has established for your contributions to be tax-deductible.
Check with your tax professional to make sure this works for your situation.
Fewer donations to keep track of
When you donate to a donor-advised fund, that’s what counts for your charitable donations tax deduction.
You don’t have to keep track of the donations you make from the fund.
That means you can fund as many charities as you like while only keeping up with paperwork from your donor-advised fund contributions.
Drawbacks of Using Donor-Advised Funds
There are some drawbacks of making a contribution to a donor-advised fund.
Money in the donor-advised fund may be subject to fees.
These fees can add up over time.
The expectation is:
Have your investments grow larger than the cost of the fees, especially over long periods of time.
How you contribute to your donor-advised fund may be limited by the organization you set it up through.
Some require large initial and additional contributions to the tune of thousands of dollars.
Additionally, your tax deductions may also be limited depending on how much you donate and your AGI.
Cash, checks, wire transfers and credit card contributions can be deducted up to 60% of your AGI in most cases.
Long-term appreciated assets are limited to 30% of your AGI, though.
How to Set up a Donor-Advised Fund
Setting up a donor-advised fund isn’t too difficult if you use a major player in the space.
Fidelity, Vanguard, and Schwab all have separate charitable organizations set up to help you start a donor-advised fund. Here’s what you need to know about each one.
Comparison of donor-advised fund accounts
|Donor advised fund||Fidelity Charitable||Vanguard Charitable||Schwab Charitable|
|Minimum initial donation||$5,000||$25,000||$5,000|
|Additional minimum contributions||No minimum||$5,000||$500|
|Administrative fees||- First $500,000: $100 or 0.6% (whichever is greater) - Next $500,000: 0.30% - Next $1,500,000: 0.20% - Next $2,499,999: 0.15%||- First $500,000: 0.60% - All amounts after $500,000: 0.30%||- First $500,000: $100 or 0.60% (whichever is greater) - Next $500,000: 0.30% - Next $1,500,000: 0.20% - Next $2,500,000: 0.15% - Next $5,000,000: 0.13% - Next $5,000,000: 0.12% - $15,000,000+: 0.10%|
|Minimum grand amount||$50||$500||$50|
To open a donor-advised fund account at Fidelity Charitable, you’ll need an initial donation of at least $5,000. After your initial contribution, there is no minimum contribution amount.
Once your account is set up, you’ll have to pay fees to cover Fidelity’s costs of managing your fund.
They charge $100 per year or 0.6% of the asset value, whichever is greater. This applies to the first $500,000 in assets. The next $500,000 pays a 0.30% fee. After that, the next $1,500,000 pays a 0.20% fee. Finally, the next $2,499,999 pays a 0.15% fee.
Additionally, money invested in mutual funds will incur investment fees that range from 0.015% to 1.11%.
When you’re ready to grant money to a charity, the minimum grant amount is $50.
Vanguard Charitable’s donor-advised funds require more money to open. A new account requires at least a $25,000 initial contribution. Additional contributions must be at least $5,000.
As far as fees go, the account will be charged 0.60% on the first $500,000. It drops to 0.30% for amounts above that in a standard account. The average investment fee is only 0.09%, though.
When you’re ready to make a grant to a charity, it must be at least $500.
To open a Core Account with Schwab Charitable, you’ll need a minimum initial contribution of at least $5,000. Additional contributions must be at least $500 each.
For up to the first $500,000 in assets, the fund will be charged $100 or 0.60% of assets, whichever is greater. The next $500,000 of assets has a 0.30% fee.
Beyond that, fees decrease to as little as 0.10% for assets in excess of $15,000,000. All fees are based on the average daily value.
Grants can be as small as $50 when you’re ready to start making them.
Who Are Donor-Advised Funds Good For?
Donor-advised funds can be good for many different people.
However, the main reason most people donate to a donor-advised fund is the tax advantages.
If you can’t take advantage of the tax benefits, it probably doesn’t make sense to open a donor-advised fund unless it really speaks to you.
If a donor-advised fund sounds like a good option for you, consult with your tax professional to verify it will work as you expect it to.
Then, consult with charitable organizations that provide donor-advised funds to find the best fit for your situation.
After that, it’s time to open your account. Once you contribute money, you’ll have to decide whether to let the money grow and when to issue grants to your favorite charities.