Could you use more tax deductions this next year? Are you charitably inclined? If the answer to these two questions is “yes,” then you may want to learn more about a Donor Advised Fund. As it stands, contributions to qualified charities are deductible on your taxes. The tax deduction is typically a nice afterthought for your annual generosity.
Where a Donor Advised Fund can come into play is if the reality of deductions is more clear than your charitable goals. That is to say, what if you know how much you need in deductions for the year, but you’re not clear on who is most deserving of the donation or the timing isn’t necessarily perfect?
This specialized account receives funds that are earmarked for charitable giving down the road. Money going into this account receive a deduction as if it were going to the charity itself. The difference is that the money stays in the account and grows tax free until you grant it to the qualified charity of your choice. When money is eventually sent to the charity down the road, no deduction is given because it was already received upon the initial contribution.
Let’s use an example. Near the end of the year your income starts adding up and an extra $12,000 of deductions would save a fair amount of taxes. Maybe you have used up other traditional avenues like retirement plans, HSAs, etc. Knowing you’d like to eventually give to one of many charities but not sure on the specifics, you contribute $12,000 to a donor advised fund while you decide. In this instance, you receive a deduction for your contribution the year in which it was made and you have the rest of your life to decide how to split your donor advised fund. While you wait, the investments inside the donor advised fund grow your available funds to grant to charities to a potentially larger sum.
Many financial firms offer donor advised funds. Here are a few questions you should ask:
- What is the minimum to get started?
- As these funds are typically invested, what investments are available?
- What are the costs involved – both hard-dollar (external) and soft-dollar (internal)?
- What is the minimum grant allowed from your donor advised fund?
- That is, how much do you have to give from your fund to a charity?
There are several other areas to look into such as administration, ease of access, etc., but these four questions are integral to getting started.
Of course, before integrating a donor advised fund into your financial strategy, be sure to consult a financial adviser, tax professional and attorney to make sure it is suitable to your particular situation.