Donor-Advised Funds: Timely, Tax-Saving Way to Give to Charity

Time’s running out to make a tax-deductible charitable contribution for 2012. If you’d like to donate at least $5,000 before the end of the year, you may want to consider doing it through something called a donor-advised fund, or DAF, which provides special tax bonuses, flexibility and anonymity.

DAFs are the fastest growing charitable vehicle in the United States, worth an estimated $43 billion, according to the National Philanthropic Trust.

They’ve become especially popular lately, as fears have grown that Congress may restrict the charitable deduction for 2013, prompting some taxpayers to set up an account while they can still rely on the write-off. In a recent Wall Street Journal article, economist and philanthropist Irving Plotkin of Cambridge, Mass., said he has tripled his DAF donation so far this year and may donate even more before Jan. 1.

The one possible downside to setting up an account and donating this year for high-income taxpayers: Congress may increase your tax rates in 2013 without altering the charitable deduction — which would make the DAF write-off more valuable than it will be this year.

The ABCs of DAFs

Here’s how a donor-advised fund works:

You give your contribution to the DAF arm of a financial institution — like Fidelity Charitable at Fidelity Investments, Schwab Charitable at Charles Schwab or Vanguard Charitable at Vanguard Group — or an organization, like National Philanthropic Trust, that specializes in tailoring donations to charities and nonprofits. This sponsor invests your gift, which grows tax-free until you tell the institution where to send your "grant," says Jennifer Immel, a senior wealth planner with PNC Wealth Management in Naples, Fla.

So, if you itemize deductions on your 2012 tax return, you can write off the amount of your grant, up to 50 percent of your adjusted gross income or 30 percent of income for appreciated investments. You can even delay a decision on which organization will ultimately get the money.

(MORE: 3 Ways to Give to Charity Before Writing a Will)

And here’s a tax bonus: If you’ll be donating stocks or mutual funds that have appreciated in value, you can get the write-off but avoid the capital gains tax by transferring the investment to your DAF, which will then sell and grant it. For example, if you sell $10,000 worth of stock and have a $5,000 capital gain, you can claim $10,000 as a deduction and won’t owe taxes on your $5,000 profit.

A few other things you need to know about using DAFs for your charitable contributions:

It's easy to set up. The institution handles all the administrative duties and paperwork. “Things are so simplified for donors that you can make a single contribution to your DAF and then recommend as many grants to as many approved charities over as long a period as you have the funds,” says Eileen Heisman, chief executive of the National Philanthropic Trust.

You can get help choosing organizations to support. Your DAF sponsor can vet potential charities for you. That can save you time and provide peace of mind that your donations will be used effectively.

DAFs are exempt from estate taxes. Donor-advised fund contributions are not subject to estate taxes or probate.

Your grants can be anonymous. This might come in handy if you want to avoid unwanted attention when making a large grant.

However, there are also a few disadvantages to donor-advised funds:

Account minimums Many institutions allow you to open a donor-advised fund with $5,000. Others, however, have a higher threshold. At Vanguard, a DAF account requires a minimum contribution of $25,000.

Strict limits on grant allocations You can’t benefit from your own donations in any way. So you can’t authorize a DAF grant to pay for tickets to a charity’s fundraising event, Heisman says. The money also cannot be used to contribute to a political party or candidate.

DAF management fees The institution will charge an annual administration fee, often about 0.6 percent of the account's value.

(MORE: How More Women Can Become Philanthropists)

Choosing a DAF

When selecting which of the roughly 750 large, charitable-fund sponsors to manage your DAF, Heisman suggests reviewing their policies regarding grant recommendations, minimum contributions, investment options, donor services and fees. “You also need to know whether you may transfer your donor-advised fund to another sponsor if you want to make a change,” she says.

Once you’ve narrowed the field of DAF companies, call your final choices to ask questions and gauge your comfort level with their operation. You may also want to consult your attorney, estate planner, accountant or financial adviser before setting up a donor-advised fund, to be sure the strategy is advisable for you.