ELITE ADVISOR BEST PRACTICES

Why Advisors Should Go DAF-fy Before Year-End

Donor advised funds offer more investment flexibility, control and tax advantages than you may be aware of

By Randy Fox

Key Takeaways:

  • DAFs are powerful, increasingly popular charitable planning tools that many advisors still don’t fully understand.
  • “Open architecture” DAFs are not under the aegis of a money management firm; thus donors may choose a portfolio of investments from a wide variety of sources.
  • DAFs have fewer restrictive tax rules and income tax deduction limits than private foundations do.
  • By familiarizing themselves with the DAF landscape, advisors can solve more complex problems for clients and cement their relationships with them.


With 2013 rapidly drawing to a close, advisors and their clients will normally discuss year-end tax planning strategies with greater urgency. One of the most common topics at year-end is charitable giving, and surveys indicate that clients are looking to their advisors for this advice more than ever. One key giving tool for every advisor to be aware of is donor advised funds (DAFs), which have been growing in numbers and popularity for the past decade or so. There are a number of reasons why DAFs have enjoyed increasing popularity, and it is incumbent on the advisory community to learn the benefits and the opportunities of this charitable planning tool.

Originated by the New York Community Trust in the mid-1930s, the DAF was the province of local community foundations and a mostly dormant strategy until the late 1990s. Since then, the growth of the DAF has been nothing short of astounding, with more than 170,000 separate accounts now in use and over $37 billion of assets on deposit.

Several factors have contributed to the spurt of growth, the most significant of which is the entry of large investment firms into the DAF environment. The three largest firms, Fidelity, Schwab and Vanguard, control more assets than do the rest of the DAFs combined. Most of the original DAFs were local in scope since community foundations are often chartered in a way that directs their grant making to the local area. For some donors, this model is effective but limiting. However, the new generation of funds is national and possibly international in reach, thereby creating almost limitless possibilities for their donors. In an age when flexibility is the mandate, the new DAFs meet this demand.

Another key ingredient contributing to the popularity of DAFs is investment flexibility and control. Often the small, local funds require control over the money management, limiting the choices for the donor and eliminating the advisor from the equation. Once again, the sheer force and size of the large national firms allow donors almost unlimited access to investment choices with minimal costs. Donors who want even more investment flexibility can seek out DAFs that offer completely “open” architecture. This means that they are not under the aegis of one of the money management firms but, instead, allow the donor to choose his or her own portfolio of investments from virtually any legitimate source. These funds include the American Endowment Foundation, the Renaissance Donor Advised Fund and several others.

Flexibility and scope are two of the main reasons for the proliferation of DAFS, but there are other attractions as well. First among them are the income tax considerations. Technically a DAF is established by a 501(c)(3) public charity. That means donations to a DAF qualify under the same rules as gifts to other public charities: gifts of cash, income tax deductible up to 50 percent of adjusted gross income (AGI); gifts of appreciated publicly traded securities, deductible up to 30 percent of AGI. Effectively, all the rules that apply to gifts to public charity apply to DAFs. This is important because DAFs are frequently compared to private foundations and private foundations operate under much more onerous and restrictive tax rules that include lower income tax deduction limitations.

Comparing DAFs to private foundations

In fact, it may be helpful to continue the comparison of DAFs to private foundations to gain a better understanding of the real power of the DAF. First, private foundations are just that: private. They are generally established by an individual or a family group and are either corporations or trusts. They have boards of directors, very specific tax rules, rules against holding certain assets, mandatory distributions of at least 5 percent of capital annually and the reduced income tax deductibility discussed earlier. However, they do allow ultimate control by the founders. Gifts can easily be given domestically or to foreign charities, investment policy can be crafted by the board to meet family requirements and desires, and succession to the next generation of leaders can be accomplished with relative ease, if so desired. Technology and scale have made the threshold contribution for starting a private foundation less expensive, but most still won’t consider the undertaking for less than $250,000. Annual operating expenses and reporting expenses may cost 2 to 5 percent of capital, exclusive of money management costs.

Getting started with DAFs

DAFs might be started for as little as $5,000, with no real upfront costs. They cost little to operate, normally a diminishing percentage of assets as they grow larger in size. Many allow “grants” of as little as $50, though there may be a limit to how many grants are allowed in a year. There is no mandatory amount that must be distributed annually, so it is common for donors to “park” donations until they decide where and how they want their philanthropic capital deployed. Donors don’t have absolute control over donations, however. The DAF can veto a gift if it sees fit. In most instances, it would be only in the case of the nominated charity not qualifying to receive the donation. There isn’t really a board that is operative, but many families elect to create quasi-boards to conduct the business of deciding on grants, investment policy and succession matters.

Gifting illiquid or hard-to-value assets to a DAF can be challenging. Certainly big institutions are less likely to want to accept out-of-the-ordinary gifts. With diligence, though, advisors can find a flexible DAF platform to work with if donating unconventional assets becomes an issue for one of their clients. By becoming more familiar with the DAF landscape, advisors can solve many otherwise challenging problems for their high-net-worth clients.

Conclusion

While this article is not intended to be a complete analysis of DAFs, it should help advisors understand that DAFs are an important planning tool to have at their disposal. With a small amount of effort and research, you can place yourself directly at the forefront of your clients’ philanthropic intentions and provide solutions to many of their planning issues at the same time.


About the Author

Randy Fox is Editor in Chief of Planned Giving Design Center and is the regional representative of Charitable Giving Resource Center.