The implementation of a Donor Advised Funds is at an all time high. Vanguard reported a 45% increase in new DAF accounts in the fourth quarter of 2017, with more than 80% of the gifts comprising non-cash assets, such as appreciated securities. Likewise, Schwab has reported a 59% increase in the number of new DAF accounts since July 1 of last year. Perhaps the increase in DAFs can be attributed to the significant appreciation in stock market portfolios. By reason of the 2017 Tax Act, some Americans who will be taking advantage of the higher standardized deductions may use a DAF to “bunch” charitable gifts in certain years. In any event, my observation is that the use of DAFs will only increase in the coming years.
For our clients who have created a DAF and who also own some tax-deferred retirement assets, we often recommend the following plan to fully utilize a DAF:
- Ordering the Gift for Tax Impact. As a tax-exempt entity, the DAF would receive any portion of a tax-deferred retirement account free of income taxes. Client should therefore first use tax-deferred retirement account assets to fund the desired gift to the DAF before utilizing other remaining assets. Since other assets generally pass free of income taxes, these assets can be allocated to the family member beneficiaries.
- Coordinating the Gift for Legal Effect. The DAF should be named as a beneficiary of the retirement account, whether primary (if the client is single) or secondary (if the client is married) in such a percentage that, if the client died then, would allow the client to completely fund the total charitable gift. For example, a single client who wishes to give $100,000 to charity at death and who owns an IRA worth $500,000 should list her DAF as the 20% primary beneficiary.
- Distributing the Gift for Charity. Following death, the client’s named successor agents can efficiently divide and distribute the DAF assets to the client’s designated charities. I find that clients appreciate the administrative ease of periodically reviewing and updating the fund agreement, as the client’s charitable objectives change from time to time.
This type of planning is not a “set it and forget it” type of planning. Rather, this type of planning requires regular communications between the clients and the client’s advisors. To address the risk of underfunding the DAF, the client’s trust agreement should include what I call a “charitable make-up” provision. By this provision, if the retirement assets allocated to the DAF are insufficient to meet the client’s charitable objectives, remaining assets from the trust can be allocated to the DAF to make up such a shortfall. To address the risk of overfunding the DAF, the client’s advisors must regularly monitor the retirement account value and the intended overall charitable bequest and make any necessary adjustments to the percentage allocated to the DAF.