In coming decades, trillions of dollars are projected to be transferred by baby boomers to charities. Instead of working through foundations and endowments, however, much of U.S. philanthropy is expected to emanate from individual donors and their families.

"Generosity is a tradition shared by people of all income levels, backgrounds and cultures," notes the Giving USA Foundation, which works each year with Indiana University to compile data on philanthropic activity. In its latest report, researchers add: 

"Mega-gifts from the wealthiest donors garner headlines and can make a big difference. But small gifts from donors of far more modest means also have a significant impact. Separately or combined, these smaller gifts are crucial to meeting individual needs and to sustaining nonprofits of all types and sizes." ¹

An increasingly popular investment vehicle to pass money and other assets to charitable causes is the Donor Advised Fund, according to the National Philanthropic Trust. In fact, the nonprofit group estimates that DAF assets entering 2022 topped $234 billion and grantmaking to charities increased some 400% in the past decade.

"Many donors use DAFs for traditional individual and family giving," the trust reports, "and an increasing number have adapted DAFs to facilitate workplace giving programs, online fundraising platforms and other models that expand philanthropy." ² 

A Donor Advised Fund (DAF) is administered by a public charity created to manage donations on behalf of individuals and families. The giver opens an account in the fund, which can be held at a major brokerage firm such as Charles Schwab or Fidelity. Along these same lines, the donor can continue to work with an IFA wealth advisor.

Here's how it works. After transfering cash or securities into the fund, you become eligible for a tax deduction and won't be required to pay capital gains on those appreciated assets. At the same time, you're typically allowed to pick the time and amount of your donations — as long as such gifts are made to an IRS-certified 501(c)(3) charity. 

In most cases, the tax deduction amount that can be claimed is:

• Up to 60% of adjusted gross income for cash
• As much as 30% for appreciated investments.

Again, there are typically no taxes on any capital gains or income that occur inside a DAF.

Donations are allowed in several different forms. These can include non-public as well as publicly traded securities, real estate, private investments and shares of mutual funds. You should be aware, however, that different rules and restrictions apply when donating real estate, non-publicly traded and other alternative types of assets. As a result, we strongly recommend that you check with your IFA wealth advisor and a DAF's sponsor before starting the gifting process. 

Below are some other major factors to keep in mind about using a DAF when trying to decide about how to make any charitable contributions in a tax-efficient manner. This list represents the collective insights of our Investment Committee.

Diversification of Holdings 

An advantage of investing through a DAF is that donors can diversify highly appreciated and concentrated positions without tax ramifications. The benefits of diversification inside such a charitable fund is that it can maximize expected returns and leave you with more assets to donate to the charities of your choice.  

Based on research by leading academics such as Eugene Fama and Kenneth French, we're confident that using a globally diversified and passively managed portfolio of index funds provides a donor with the best opportunity to maximize expected returns over time. IFA's portfolio managers have found that thoroughly researched diversification strategies can reduce portfolio volatility — without sacrificing expected returns. 

Nobel Laureate Harry Markowitz was one of the first academics to research and document the investment benefits of adding more uncorrelated assets to a portfolio. His work in understanding risk and how it applies to stock markets was seminal in the development of what became known as Modern Portfolio Theory. This appreciation of MPT's attributes is why each IFA Index Portfolio is designed to provide clients with exposure to more than 13,000 companies across 40-plus countries. 

Besides diversifying across asset classes, academic researchers like Fama and French have identified certain criteria as major drivers of expected returns — as well as key determinants of investment risk. These premiums available to investors include characteristics (or "factors") of stocks such as size, value and profitability. As a result, IFA's portfolios are built using index funds that emphasize these factors. 

Investment Minimums and Portfolio Guidance

Typically, donors can pick investments using pre-selected portfolios offered by the DAF sponsor. But in DAFs referred by IFA, they can also choose to work with their independent wealth advisor to invest in a customized portfolio using a variety of different mutual funds and ETFs. (IFA accepts no referral fees or direct compensation from DAFs.) 

With this option, however, it's important to check minimum account requirements since such investment thresholds can vary greatly across different charitable organizations. 

In general, DAF sponsors don't set account size minimums as high to use their pre-set inventory of funds. For example, the charitable organizations established by Schwab and Fidelity to oversee DAF programs have no minimum investment requirements to open an account. To work with an advisor to help design and implement your portfolio, though, both DAF programs require at least $250,000 to get started. 

Another charitable organization that IFA has referred clients to in the past is the American Endowment Foundation. The Ohio-based philanthropic group mainly works with donors using investment portfolios designed by their advisors. To set up a DAF account, AEF typically requires a minimum of $25,000 in assets. 

"We're not offering a choice of certain funds to invest in," a senior AEF philanthropic excecutive told us, "because we think it's important for clients to discuss with their advisors how best to set up any charitable portfolios and make sure those allocations are consistent with their other investments."

Managing Paperwork and Complexity

The costs and minimum account sizes required by a DAF are likely to be far lower in general than establishing and maintaining a private foundation. It's also probably going to require much less in terms of paperwork, legal fees and related complexities necessary to setting up and maintaining a foundation.

In fairness, however, a private foundation has the advantage of not being limited to giving only to charitable organizations. Foundations are also sometimes utilized as a means of employing family members.

It might be worth considering, however, that investing through a DAF can still provide a means to involve your family members in philanthropic and other transfer-of-wealth decisions. In fact, a DAF can be used as a tax-efficient companion vehicle to a charitable trust — or, to a private foundation. It can also generally be used to accept donations from any of these vehicles. 

Estate Planning Benefits and RMDs 

One of the ways DAFs are most frequently used is as an estate planning tool. DAFs are particularly well-suited to distributing assets not only to charities, but also to successor donors after a DAF's last account holder has died.

In terms of estate planning, this can open up avenues for an estate to continue its philanthropic activities as assets held in such funds can be passed along to a new generation of wealth builders. 

Charitable giving can also serve in some cases as a useful estate planning tool for dealing with Required Minimum Distributions. But you're going to need to be aware of some caveats in using RMDs to place your estate in a better tax-advantaged situation. 

Technically, the IRS will allow investors aged 70 1/2 or older to use up to $100,000 each year of their RMDs for charitable donations, according to Kyle Casserino, a charitable planning consultant and vice president at Fidelity Charitable. "DAFs and foundations aren't considered as eligible for qualified charitable distributions from your traditional IRA account during your lifetime," he notes.

A strategy that some families are implementing, however, is to make a DAF the charitable beneficiary of the DAF. "In this manner, assets can be passed from one tax-efficient vehicle to another while allowing your next generation to continue the family's legacy of philanthropy," says Casserino.

Each person's situation can vary greatly, of course. IFA's wealth advisors typically recommend clients with estate planning questions talk to an attorney specializing in that field. 

Fees and other Costs

So how much does it cost to use such funds? 

To compensate the sponsor for the administrative expenses of running a DAF, there is an annual fee that will vary with the size of the account. For both Schwab and Fidelity's charitable organizations, the annual fee is 0.60% for the first $500,000 and tiers down from there. The American Endowment Foundation charges annual management fees of 0.70% up to the initial $500,000.

IFA can help you to research specific DAFs and discuss broader philanthropic strategies, both in terms of investing and tax planning issues. We invite any clients who are considering how best to engage in philanthropic endeavors to contact their respective IFA wealth advisor. You can connect with an IFA wealth advisor by clicking here or by calling us directly at: (888) 643-3133. 

Footnotes:

1). Giving USA Foundation, "Giving USA 2022," July 2022.

2.) National Philanthropic Trust, "2022 DAF Report," Nov. 15, 2022.

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This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Investing involves risks, including possible loss of principal. This is intended to be informational in nature and should not be construed as tax advice. IFA Taxes is a division of Index Fund Advisors, Inc.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.