Improper Use of a Donor-Advised Fund
A Donor Advised Fund is an excellent tool to maximize your charitable giving while minimizing your tax burden. I like to think of these accounts as a charitable giving account. How these accounts work is you donate cash or other assets such as stocks, bonds, mutual funds, etc. and the amount that you contribute gives you a tax deduction.
Whatever you choose to donate, your contributions are irrevocable and completely dedicated for charitable giving. But once you make the contributions to these accounts, those funds sit in the account until you’re ready to grant or transfer those funds.
Now, you can choose from a list of thousands of different qualified charities, whether that’s your alma mater, religious organization or local food bank. There are a variety of practical applications on how you can use a Donor Advised Fund. Oftentimes, the savviest thing is to donate long-term appreciated assets like a stock, bond or mutual fund.
This allows you to potentially eliminate the capital gains for tax that you would otherwise face, while also receiving an income tax deduction. Another application is if you’re anticipating the sale of a business or expecting a large tax year. This can come in the form of receiving a severance or selling an investment property. Because of the extra taxable income that you would have to report, that may cause a bigger tax year for you.
So by contributing, making these contributions, you can essentially reduce your taxable income by making these contributions.
A Donor-Advised Fund Helps Reduce Taxes
Now, there are ways that the Donor Advised Fund can be helpful to reduce the tax impact of these big tax years. But, if done improperly, it can reduce the benefit that you actually receive from this strategy. I wanted to go over a few of those mistakes that we see and how to avoid them.
First, some people may invest the money in their Donor Advised Fund too aggressively. But, by investing too aggressively in those funds, in any given time, the market could go down and have less money there to be able to use for you charitable giving goals.
Another common mistake is contributing too much to a Donor Advised Fund. Now, there’s a lot of people that get carried away with these strategies and think that they should just contribute as much as they can. However, they should be aware of how this plays in with other tax planning strategies that they may need to consider like a Qualified Charitable Distribution or a Roth conversion, etc..
And by overlapping these strategies, they may reduce the benefit of one tax strategy or the other.
Lastly, if you’re planning on gifting the funds directly to a charity, then there’s no reason to set up a Donor Advised Fund there. There are a lot of qualified charities that accept stocks, bonds, mutual funds, and you can transfer those directly to the charity without having to set up an account like this. These accounts are particularly suited for those who regularly give to charities, and planning on making a large contribution for tax purposes, but don’t plan on sending all of that money to the charity right away.
A Donor Advised Fund can be a huge tax planning tool for those who are anticipating a large tax year and can be an excellent tool to maximize your charitable giving efforts in a tax efficient way.