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Don't Overlook Donor-Advised Funds for Charitable Giving

Baird's Tim Steffen walks us through the tax and timing advantages of using donor-advised funds.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Director of financial planning at Baird, Tim Steffen, thinks that investors should consider donor-advised funds for the charitable giving.

Tim, thanks for joining me.

Tim Steffen: It's great to be here.

Glaser: Let's talk a little bit just with definitions what a donor-advised fund is and how and an individual investor could use it.

Steffen: Sure. So, the way we kind of position donor-advised funds is, it's a miniature version of a private foundation. So, you think of the private foundations, the Gates Foundation and some of those others out there, they make big gifts, money sits in there, and over time the foundation doles it out to a charity. A donor-advised fund is really a smaller version of that for the mass public. You make a contribution to the account today; you get your tax benefit today; and then over time you make grants out of that fund to individual charities as you see appropriate.

Glaser: So, what's the advantage of that to just selling the securities and writing the check to the charity or transferring the appreciated securities? Why would you want to do this?

Steffen: Well, the upside of this is that you can accelerate your gifting, make all the donations and get the tax benefits right away without having to actually decide where that money is going to go, which charity is going to benefit from that. So, maybe for somebody who has a spike in income for a particular year and would like to get the tax benefit of that deduction earlier rather than later, they make the gift today, and then over the course of the ensuing years or months or however long they want to take, they can decide who is actually going to benefit from that gift. So, you get the best of both worlds. You get the tax deduction upfront plus the time to decide who is going to get the gifts.

Glaser: If the tax deduction is a big driver, is this really only for taxable money? Would you ever transfer an IRA asset or anything like that into a donor-advised find?

Steffen: You could name one of those as maybe a beneficiary of it or as a beneficiary of your IRA. But the donor-advised fund is really for people who want to get tax deductions upfront.

Glaser: So, let's talk about exactly the mechanics of how that would work. Can you kind of maybe walk us through an example of how that would happen?

Steffen: Sure. So, an individual, maybe they've got a commitment to make gifts to a church or a school over a period of time, over a several-year period. So, they would then open up the donor-advised fund--and you can do that in a number of different ways. A lot of the larger mutual fund companies or maybe even some banks might offer these as an option. So, you open your account with them, you make the donation, you transfer the assets into that--that can be cash or appreciated securities. Some of the funds will even take other types of assets. The assets or the funds go into that account, you get a tax deduction for the fair market value of what you donated. And then you have an account basically where you can direct gifts out of that as you see fit.

The amount of the gifts and the frequency of the gifts is going to be dictated by the organization that's supporting it, so whether it's one of the mutual fund companies or somebody else. Often you see gifts as small as $50 coming out of those. So, it's not for--it doesn't have to be for large donations. These can be for small bequests. In terms of funding the account, again, that's going to be driven by the sponsoring company. It might be as small as a $5,000 gift. So, again, we're not talking hundreds of thousands that have to go into these things. These can be small donations into the fund and then even smaller grants out of the fund. So, it's really for the general public.

Glaser: And what are some of the companies that offer these donor-advised funds?

Steffen: Sure. Fidelity has been around for a long time with one. Templeton has one as well. And then there's groups called like the American Endowment Fund that offer versions of it as well. So, there's a lot of them out there.

Glaser: And once you put the money into the fund, you have to choose how to invest it. Does it makes sense to be more aggressive, to be more conservative? How do you think about that?

Steffen: So, the different sponsors of these will offer investment options. Sometimes you can just elect to be in a pool of funds, kind of like you would do with a 529 plan for college funding. You say, I want your growth income model and they will invest within a pool of their mutual funds typically. So, if you went to a particular fund company, you'd be invested in their funds, and it would be a set pool and you wouldn't really control the allocation of that. Others, maybe for larger donations, will allow you to pick the specific funds or even work with maybe an outside manager. So, if you had an advisor at another firm maybe, you could work with them to select the specific investments and manage it yourself.

Glaser: Well, Tim, thank you for giving us the information on donor-advised funds today.

Steffen: Great to be here.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.