One of the most practical tips I learned in law school was from a Wills & Trusts class. No, it wasn’t about how to plan for your death. It was about how to plan for your life, specifically when it comes to donating money. The term I heard in that class, that I had never heard about before, was “donor-advised fund.”
We learned that this was similar to a charitable trust, but with some unique differences.
I don’t know about you, but to me, setting up a charitable trust or anything similar sounded like something only rich people would or should do.
However, it turns out you don’t have to be one of the ultra-rich to have a donor advised fund. You can and should set one up.
Why Should You Set Up a Donor-Advised Fund?
There are many advantages to setting up a donor-advised fund.
1. Low Set Up Costs
To set up a donor-advised fund, you need to contribute as little as $5,000. Fidelity offers this option. Keep in mind Vanguard requires a heftier amount of $25,000 as your initial contribution.
2. Immediate Tax Donation
When you set up a donor-advised fund, you get an immediate deduction for the year you set it up. So, if you initially fund your fund with $5,000, you get a tax deduction of $5,000 for the year.
3. No Immediate Distributions Required
While you get a tax write-off the year you establish your fund, you don’t have to distribute all (or even any) of the funds in it that year. Rather, you can use the money in it to contribute to charities over time.
4. Great with Our Current High Standard Deductions
With the recent change in tax code to increase the standard deduction, a lot more people are opting to rotate between standard deductions and itemized deductions.
For example, if you normally contribute $3,000 to charities throughout the year, pairing this with the rest of your itemizations may not be enough to hit the standard deduction amount. BUT, if you contribute $6,000 or even $9,000 to a donor-advised fund this year, this allows you to itemize your deductions this year. Then, for the next 2-3 years, you can still donate the same amount each year to charities and take the standard deduction instead of itemizing.
5. Tax-Free Growth
One of the biggest benefits of donor-advised funds is tax-free growth. You can invest the funds you have in the account and they grow tax-free. Then, you have even more money to contribute to charity.
As a side note, for the ultra-wealthy, their charitable trusts and donor-advised funds might be set up so that they are only giving away the earnings from the trust each year and not the principal. This means that if you had $100,000 and were earning 6% in dividends or interest, you could give away $6,000 a year and the money would never run out.
For the rest of us, we are giving away the principal plus interest. But, it’s nice to have something to aspire to.
6. Ability to Contribute Long Term Stocks and Avoid Capital Gains Taxes
Rather than contribute cash to your donor advised fund, you can also contribute stock. If you donate stock, you get the value of the shares at the time you make your contribution. Additionally, you don’t pay tax on the earnings.
For example, say you bought 1,000 shares of Peloton stock at $20/share and a year later they are worth $120/share. If you sold these shares, you would be taxed on the gains (so you’d be paying tax on $100,000). Then, you would have just the money left (at 15% capital gains tax this would be $105,000) to donate. This would earn you a $105,000 tax write off.
Instead, you can donate these shares directly to your donor-advised fund. Then, the fund can sell the shares tax-free. In this example, you get a $120,000 tax write off. This helps you get $15,000 more to charity than you did before.
How do you set up a Donor-Advised Fund?
If you want to set up a donor-advised fund, start by finding a provider. For my budget, I stuck with Fidelity due to their low minimum of just $5,000 to open an account.
Now, you might not have $5,000 right away to set up an account. How do you solve this problem? Just contribute regularly to a savings account you have designated for this cause. Then, once you reach the minimum, you can set up the account.
When I first set up our account, I had been setting aside money every month to be able to reach the minimum. Now that I have my account set up, because I am rotating years with my standard deduction, every month I still put money in a savings account set aside for my charitable giving. Then, every other year, I contribute it to my donor-advised fund.
Do you have a donor-advised fund? If not, what is holding you back?