The benefits of making contributions to a donor-advised fund include immediate tax deductions, tax-free growth and investment choice.
But that doesn’t mean that the funds are a fit for everyone or that there aren’t differences in the funds run by the big three—Fidelity, Schwab and Vanguard, according to a new blog from Amy C. Arnott, a portfolio strategist for Morningstar Research Services.
A donor-advised fund is a 501(c)3 organization that allows investors to take an immediate tax deduction for contributions of cash or assets they make, while retaining some control over assets.
“Although the contributions are irrevocable, meaning you can’t withdraw donations if you change your mind or need extra cash, the donor retains an advisory role over how to invest the assets and how much to contribute to various charities,” Arnott said.
All of these attributes have contributed to the popularity of donor-advised funds, which took in $234 billion in donations in 2021, according to the National Philanthropic Trust.
The tax law changes of 2018, which made it more difficult to itemize in order to deduct charitable donations for tax purposes, also made donor-advised funds even more popular, Arnott said.
Since most investors now take the standard deduction instead of itemizing, “donor-advised funds allow them to ‘bunch’ charitable donations by making a larger donation in a single year, which might push you past the threshold for itemized deductions, instead of making smaller annual donations that might not be tax-deductible,” Arnott said.
While investors can take the itemized deduction up front, they can still make charitable contributions over time, she added.
Donors contributing cash can take a deduction of up to 60% of adjusted gross income. Donors contributing securities or other assets can take a deduction of up to 30% of adjusted gross income and donate a wide-range of assets including stocks, bonds, funds, cryptocurrencies, privately-held business interests and restricted stock.
“The in-kind tax deduction can be especially valuable for highly appreciated assets because it allows investors to remove these assets from their taxable portfolios, thereby improving diversification and mitigating security-specific risk, without taking the tax hit associated with the embedded capital gain,” Arnott said.
The donor-advised fund “takes care of selling the appreciated asset, but there’s no realized capital gain to report,” she added.