What is a Donor-advised Fund (DAF) and How Do They Work?
A Donor-Advised Fund (DAF) is a charitable giving vehicle that donors can use for their philanthropic activities. It allows individuals to make tax-deductible contributions to a fund maintained by an organization, which supports DAFs. Donors can then recommend grants from the fund to eligible non-profit organizations over time, providing flexibility, anonymity, and simplified management of their charitable giving.
Table of Contents
- How to Start Contributing to a Donor-advised Fund
- What Kind of Contributions Can You Make?
- Donor-advised Fund Recipient Qualifications
- Benefits of a DAF
- Drawbacks of a DAF
- How are Donor-advised Funds Different from Private Foundations?
How to Start Contributing to a Donor-advised Fund
To establish a donor-advised fund, a donor generally selects a sponsor that offers DAF services, such as a community foundation, public charity, or financial organization like Fidelity or National Philanthropic Trust. Contributions can be made directly to these funds.
The process for establishing a DAF typically involves:
- Completing an application
- Making an initial contribution to the fund
- Signing a donor agreement
Once the DAF is established, the donor can recommend grants from the fund to eligible nonprofits!
It’s also important to note a second type of DAF that arises through workplace giving programs and peer-to-peer fundraising campaigns. In these cases, the donor may not directly choose to use a DAF, but instead, it is facilitated by the chosen platform.
For the purposes of this article, we will primarily focus on the first type of DAF mentioned.
What Kind of Contributions Can You Make?
Donors can make contributions to their DAFs in a variety of forms. The most common is cash, but appreciated securities such as stocks, ETFs, and mutual funds are often accepted. In some circumstances, the DAF will even allow collectibles, bequests from wills or trusts, or matching gifts. Make sure to check with your organization to learn more about their specific rules and regulations for contributions.
Important note: All contributions are done irrevocably. This means that the fund sponsor owns the assets as soon as they are received.
Donor-advised Fund Recipient Qualifications
While DAFs allows the donor to suggest grant recipients, the sponsor has final say on approval. They will check to make sure the suggested nonprofit is eligible to receive the grant. Due diligence includes making sure the recipients are:
- Registered as a 501(c)(3) nonprofit organization
- Not engaging in prohibited activities such as lobbying or political campaigning
- In good standing with the IRS and has a valid tax-exempt status.
- Using grant funds for charitable purposes (program support, operating expenses, etc.)
Some DAF sponsors may have other specific criteria, such as geographic restrictions or that they align with a certain mission. If the criteria is met, then the sponsoring organization will distribute the requested grant to the requested charity.
Six Benefits of a DAF
- Tax efficiency: When funding a Donor-Advised Fund (DAF), your contributions are tax-deductible in the same year, providing an immediate financial advantage. This tax deduction applies at the funding stage; however, please note that subsequent distributions from the DAF are not tax-deductible for the donor.
- Flexibility: DAFs allow donors to make contributions as often as they like. Also, they can recommend making distributions to multiple organizations throughout the year from one single fund.
- Ease of use: Unlike private foundations, the sponsors will handle administrative tasks, such as receiving contributions, investing the funds, and distributing grants.
- Investment options: DAFs offer a range of investment options, allowing donors to choose how their contributions are invested which can potentially grow over time.
- Privacy: Donors can choose to remain anonymous when making grants from a DAF, which can be beneficial for those who wish to keep their charitable giving private.
- Legacy giving: DAFs can be used as a tool for legacy giving, since donors can name successors to their DAF, ensuring that their philanthropic goals are continued once they pass away.
Three Potential Drawbacks of a DAF
- Limited control: While you’re allowed to make recommendations on how contributions are distributed, the sponsoring organization ultimately has the final say.
- Costs and fees: Some organizations charge investment and administrative fees which can eat into your contribution gains over time.
- Limited transparency: While DAFs offer donors the option to remain anonymous when making grants, a potential drawback for nonprofits is the hindered ability to build and nurture relationships with these donors which can jeopardize long term support for the nonprofit organization.
How are Donor-advised Funds Different from Private Foundations?
A private foundation is a type of charitable organization that is established by a single individual, family, or corporation to support specific causes or organizations.
Unlike donor-advised funds (DAFs), which are sponsored by community or public organizations, private foundations are established as separate legal entities with their own board of directors or trustees.
Here are some other key differences between private foundations and DAFs:
- Costs and fees: Private foundations typically have higher start up costs and maintenance fees than DAFs, making them more appropriate for donors with larger amounts of charitable assets.
- Tax Deduction Limits: DAFs have a tax deduction limit of up to 60% of your adjusted gross income and 30% for private foundations. Private foundations also have to pay an excise tax based on their net investment income.
- Control and flexibility: While there is more compliance and regulation, private foundations allow full control over who receives grants from the fund. In DAFs, the sponsor has the final say for grant recipients.
- Anonymity: Donors can choose to remain anonymous when making grants from a DAF, whereas private foundations require public disclosure through informational returns.
Is there a minimum grant amount?
To make sure accounts stay active, most DAFs will require a minimum grant amount and frequency per year. For instance, some DAF sponsors require a minimum grant frequency of every two years and a minimum grant amount of $50. If no grant is made during that time frame, they take part of the balance and give it to a IRS-qualified public charity of their choosing.
How can I find a nonprofit to suggest for DAF distributions?
To find a nonprofit to suggest for Donor-Advised Fund (DAF) distributions, you’ll want to focus on organizations that are in good standing with the Internal Revenue Service (IRS). These eligible charities can be found in the IRS Business Master File, which is accessible through the IRS website or your DAF sponsor.
At Blackbaud, we offer an additional avenue for locating suitable nonprofits. By using either their YourCause or JustGiving solutions, donors can access not only the IRS Business Master File but also vetted schools and houses of worship that qualify for DAF distributions. This comprehensive approach ensures that you have a wide range of reputable organizations to choose from when making your DAF recommendations.
Can donors make anonymous grants from their DAF?
Yes, typically speaking, donors can choose to remain anonymous when making grants from their DAF.
What happens to a giving account after a donor passes away?
The donor typically designates a successor advisor or a charitable organization to take over the account after their passing. The advisor is usually someone the donor trusts, such as a family member or close friend, and they will be able to recommend grants to charities from the remaining balance of the account.
If the donor did not name a successor or organization, the DAF sponsor may use its own discretion to distribute the remaining balance to charities that align with the donor’s philanthropic interests.