Donor advised funds for regular givers

In short

A friend of mine once kept a shoebox of charity receipts, and every April she dreaded sorting it. If you give to charity each year, a donor advised fund may be worth understanding. It is an account held by a public charity, and you put money in once and send it to charities over time. The tax deduction comes when the money goes in, not when it goes out. Many givers use it to bunch several years of gifts into one year so they can itemize. The fund charges fees, and the gift cannot be taken back. Read the sponsor's fee page and its grant rules before you open one.

The whole of it

What it is

I once watched a neighbor fill a coffee can with coins all year, then hand it to the church at Christmas. A donor advised fund works a little like that can, only it is a good deal more formal. A public charity, called the sponsor, holds the account. Community foundations and the charitable arms of big investment firms often act as sponsors. You give cash or other assets to the sponsor, and the gift is final. The money now belongs to the charity.

Here is the part folks find odd. You get to recommend where the money goes later. The sponsor has the legal say, but it almost always follows a donor's advice, so long as the recipient is an eligible charity. That is where the word advised comes from.

Not a loophole, just a tool. Treat it that way.

How it works

You have probably sat down at the end of a year and wondered whether your giving counted for anything on your tax return. The answer often turns on the standard deduction. This is a flat amount the tax code lets you subtract from income without proving any expenses. If your gifts, plus your other itemized costs, fall below it, your giving adds nothing to your return.

A donor advised fund lets a giver bunch gifts. Instead of giving $4,000 each year for three years, the donor puts $12,000 into the fund in one year. That year, the donor itemizes and takes the deduction. In the next two years, the donor takes the standard deduction. Meanwhile, the sponsor sends $4,000 a year to the donor's chosen charities. The charities see the same steady support, and the donor gets a deduction that would otherwise have been lost.

Gifts of appreciated stock held longer than a year work well here too. The donor generally avoids capital gains tax on the growth, and may deduct the full market value, within the limits the IRS sets. Those limits depend on the type of asset and your income. The IRS explains them in Publication 526, Charitable Contributions.

While the money waits in the account, the sponsor usually invests it, and the balance can rise or fall. The sponsor takes an annual fee for running things. Some sponsors also set a minimum to open the account and a minimum for each grant.

The numbers, and where to find yours

If you are holding an old tax return, you can find your standard deduction on the form itself. The amount for this year is the current figure, which the official source publishes each year, and it changes most years. The IRS publishes it in the instructions for Form 1040.

Your deduction for gifts of cash to public charities is capped as a share of your income. The cap is the current figure, which the official source publishes each year of adjusted gross income, which is the income figure near the bottom of page one of your return. Gifts of appreciated stock face a different cap, the current figure, which the official source publishes each year. Anything over a cap can generally be carried forward for up to five years. Check Publication 526 for the details.

Fees are different for every sponsor. Each one posts a fee schedule. Look for the annual administrative fee, expressed as a percent of the balance, and the separate fees charged by the investment funds inside the account. Add them together. That total is the true yearly cost.

A worked example

A woman I will call Margaret is married and files jointly with her husband, Tom. They give $4,000 a year to their church and a food bank. Their mortgage interest and state taxes come to $14,000 a year. For this example, say the standard deduction for joint filers is the current figure, which the official source publishes each year. Suppose that figure works out to $29,000 on the year they file. Their itemized total is $14,000 plus $4,000, which is $18,000. That is below $29,000, so the gifts earn them nothing on the return.

Then Margaret hears about bunching. In one year, she and Tom put $12,000 into a donor advised fund. That year, their itemized total is $14,000 plus $12,000, which is $26,000. Still under $29,000, so they gain nothing yet. Honest math matters here. They would need a larger gift.

So they try $16,000 instead, enough for four years of giving. Now the total is $14,000 plus $16,000, which is $30,000. That beats $29,000 by $1,000. In the other three years, they take the standard deduction of $29,000 as usual. The extra $1,000 of deduction, at a 22 percent tax bracket, saves $1,000 times 0.22, or $220. A modest gain.

Each year, the fund sends $4,000 to their church and the food bank. After four years, $16,000 has gone out, plus or minus investment results, less fees. Say the sponsor charges 0.60 percent a year on an average balance of $10,000. That is $10,000 times 0.006, or $60 a year, or $240 over four years. The $220 saved nearly vanishes against the $240 in fees. Margaret learns something useful. For a small giver, the tool may barely pay.

If Tom and Margaret gave appreciated stock instead, the picture shifts. Say they bought shares for $5,000 that now sit at $16,000. Giving the shares directly avoids tax on the $11,000 gain. At a 15 percent capital gains rate, that is $11,000 times 0.15, or $1,650 saved. Now the math looks different, and the fee is easy to cover.

Where it goes wrong

I have seen good people trip on this, so let me say it plainly. The gift is irrevocable. Once the money is in, it cannot come back to your own pocket. A giver who might need the cash should keep it.

Another trap is the waiting game. The law sets no yearly payout rule for these accounts, and some money sits for years. The charities you care about get nothing until you recommend a grant. Many sponsors have their own inactivity rules, so read them.

Grants cannot buy you anything. You may not use the fund to pay a pledge you legally owe, to buy tickets to a dinner, or to hand a benefit to yourself or your family. The IRS treats that as a problem. The IRS also explains these rules in Publication 526 and in its guidance on donor advised funds.

Fees can quietly eat small balances, as Margaret found. Last, the deduction only helps when you itemize in the bunching year. Run your own numbers first.

Questions to answer before you leave this page

Have you added up what you give each year, and does it come anywhere near the gap between your itemized costs and the standard deduction? Do you hold stock that has grown a good deal, which might make a gift of shares cheaper than a gift of cash? Are you comfortable that a gift to the sponsor can never be taken back? What is the sponsor's total yearly cost, once the account fee and the fund fees are added together? Does the sponsor set a minimum to open the account, and a minimum for each grant? How long are you willing to let money sit before it reaches a charity you care about? And have you looked at Publication 526 to confirm the deduction limits that apply to your own return?