As we get into the end of the year tax planning season, I'd like to revisit a tool we find ourselves using more and more often in the practice, the Donor Advised Fund, or DAF.
A Donor Advised Fund in its most simple description is a charitable investment account that can receive contributions of a variety of assets including cash, stocks and bonds, to ultimately benefit 501(c)3 charitable organizations as directed by the individual or family donors who set up and manage the account.
Donations of financial assets to the DAF are tax deductible to the donor in the year the contribution is made, assets inside the account appreciate on a tax-free basis and the account is not required to distribute any set amount on an annual basis.
A couple of important specifics to understand about DAFs is that while the management and disbursements of the account remain under the control of the donor, the funds are actually owned by the sponsoring financial institution, typically a brokerage firm or mutual fund company, and cannot be reclaimed by the donor for personal use.
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In addition, the charities eligible to receive tax preferred gifts from the DAF must be designated non-profit organizations qualified under the IRS 501(c)3 code, so no, needy adult kids and delinquent brothers in law do not qualify for DAF distributions.
While donations to the DAF are irrevocable, meaning they cannot be reclaimed, what I like best about this planning tool is the overall flexibility it offers. In our practice we have been using DAFs to manage the taxes associated with highly concentrated, highly appreciated stock positions (one AI tech stock in particular), manage the taxes in situations where a closely held business is being sold, unlocking large capital gains, or even more complicated situations involving appreciated real estate.
Sometimes the intention to use charitable giving is linked to a family's financial and tax planning, and not necessarily an immediate identified cause or organization. In these situations, the DAF really shines, as it enables the charitable intent but does not require immediate decisions about how to ultimately gift the funds. I think DAFs can also facilitate charitable giving conversations within a family, in that maybe the financial planning to fund the DAF is the purview of parents, but once funded, others in the family can be engaged to decide how the funds may ultimately benefit the community or causes that are important to various family members.
Another important way DAFs can be incorporated into planning is as the beneficiary of an IRA or 401(k). When a DAF is named as the beneficiary of an IRA the process of funding the IRA at death, especially when the IRA and DAF are serviced by the same financial institution, is far simpler in my experience than direct gifts to a charitable organization, which frankly can be a bit clumsy to implement.
Once the DAF is funded, the ultimate instructions to the individual chosen to direct the fund after the donor's passing can be as simple as a notebook left by the donor, and can be changed anytime without the need to amend estate planning documents or change beneficiaries on an IRA. I personally will be including a DAF as one of the beneficiaries of my retirement plans.
Getting the money to the organizations intended by the donor can be as easy as requesting the financial institution sponsoring the account to cut and send a check.
It is important to note a DAF cannot receive donations by Qualified Charitable Distributions from an IRA, which still must be directed to a receiving charity.
We will get a lot more visibility on federal tax policy after this week's election. Regardless of how the election plays out, the need for tax planning in general will be important. Donor Advised Funds will continue to be an oft used tool in our planning toolbox.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at [email protected]. Securities offered through LPL Financial, member FINRA/SIPC.
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