2017. This is the year that we established our Donor-Advised Fund (DAF). If you are not familiar with DAFs, join us for a discussion about some of the reasons we are establishing one. We’ve also provided links to other bloggers who have done the same for more perspectives. This was one of our financial goals for 2017, so we are glad that we have ticked this off our to-do list.
Wouldn’t it be marvelous to have a separate fund of assets from which you could pull a safe-withdrawal rate and continue to give to your preferred charities, even in retirement?
That is our goal. We want to continue to support certain organizations (and emergency response efforts when disasters occur) without affecting our early-retirement or traditional-retirement spending plans. 2017 has been a year full of reminders that disaster may strike at any time and when it does, the need is great. We haven’t always been fantastic about sharing in our good fortune, but we are striving to be better and we want to establish the means to keep this going.
What is a Donor-Advised Fund?
According to Fidelity, DAFs are the fastest-growing charitable giving vehicle in the U.S because “they are one of the easiest and most tax-advantageous ways to give to a charity.”
The basic concept is that you front-load charitable giving into a separate fund, managed by you, invest those assets and distribute to charities of your choice in the future. All of this occurs in such a way that you get an immediate tax deduction (up to limits, of course) in the year you donate the assets (but not when you distribute the money).
This is ideal for us, because right now our taxable earnings are high during the peak of our traditional careers. When we become early retirees, our income is likely to be very low until we are over age 60 and start pulling from our 401(k) and IRA accounts. At that time, we may not need any further deductions beyond the standard exemptions for a married couple but we’d like to continue to give.
The figure below is a refresher from an earlier post on tax-related issues. We are right in the middle in our ‘Peak Working Years’:
Why Would You Want to Open a DAF?
Obviously, opening a DAF is just one way to establish charitable giving. You could simply give directly to charities of your choice and if you itemize your deductions, you may receive tax reductions when you file your federal and/or state taxes. Currently, you can deduct up to 50% of your AGI when you donate directly or donate through a DAF. Currently, there are phase-out limits where itemized deductions (including charitable giving) are reduced. We are fortunate to be in this phase-out zone (AGI over $313,800 for MFJ), but closer to the front end, rather than the full-phase out limit of 80%. We still get a reduction in our taxes when we donate to qualifed charites.
Here is a run-down of some the pros that supported our decision making:
Uncertainty of Tax Deductions – If you are following the evolving tax reform conversation here in the U.S., it is clear that our current understanding of tax deductions and ‘write-offs’ is under the microscope and changes may be on the horizon. Although it appears for now that some charitable giving may continue to be deductible, it remains to be seen if new income limits may apply or annual caps to deductible giving in the very near future. For this reason, we feel confident that we should not push off our decision to establish a DAF any further. While we are in high-income years, we want to take full advantage of the tax break as it exists today. We plan to continue to add to the fund while we are still working, but we will be watching these developments carefully.
In 2016, we ended up in the 33% federal tax bracket (about 24% effective rate) and we paid 8% for state. So charitable giving has the effect of being ‘more valuable’ to us in terms of deductions than any time in our earning history. In future ‘retired’ years, we may be in the zero or 10% tax bracket (pending reform changes) so our tax incentive to claim would be nonexistent, or very low. However, we still want to be able to give. Obviously, tax incentives are not our primary motivation, but we like to reduce our tax bill any way we can.
Growth Potential on Tax-Free Basis – Perhaps one of the biggest advantages to us in opening a DAF, is the potential for growth. Since you can invest the funds and delay your giving, the funds have a chance to rise in value and this growth is shielded from further taxation. Depending on this growth, the fund can be self-replenishing if you take just a little out each year (say 4% or less). In this way, we want to treat our DAF as a micro-retirement account all in itself with its own safe withdrawal rate (SWR). This is key to maintaining the ability to donate many years in the future no matter what else is going on with our financial picture.
Anonymity – I hate to see charities that I have donated to in the past waste time and money on repeat solicitations. The calls. The request letters. The emails. I may or may not choose to continue to contribute to these same organizations, but the idea of being able to contribute anonymously is very attractive to me. I don’t give to these organizations because I need a big splashy thank you (I do want a receipt for our taxes though). In fact, I would prefer they save their money and use it for the original mission rather than spending on additional printed mail to me or using volunteer time to call me to ask for more money. I know it’s hard to get your message out there and it’s an important part of fundraising, but I also see a tremendous amount of waste.
Ability to Name Successors – Many of us want to leave a little something behind us when we depart this awesome planet. It’s too early to tell if we’ll have anything to leave to our family at the end of our days, but if there is a balance in our DAF at the time of our demise, we can name a successor to take over the distribution decisions of our DAF. This may comfort our family in knowing they can use other inherited assets for their personal benefit and continue our desire to fund organizations that are important to us.
Although we’ve been inspired by other bloggers who have done the same, we were left with some questions about the mechanics of opening and maintaining a DAF and so we’ve added some additional information below which may be helpful to others.
Do You Have to Maintain a Minimum Balance?
It appears that you do not need to maintain a certain balance in a DAF and could give the entire balance out at any time. However, providers do require a minimum to open a DAF. The minimum at Fidelity is currently $5,000 and this is who we decided to go with for our account. We originally looked into Vanguard for our DAF, but their minimum amount to open an account was $25,000. Furthermore, Vanguard requires subsequent contributions to be at least $5,000. Those minimums are a bit too high for us.
Are there any Special Timing Rules?
Unlike contributions to an IRA which could occur up until the tax filing deadline for the prior year, contributions must be made by December 31st in order to claim the deduction for the current taxable year. This deadline is consistent with direct donations. So, you don’t get any extension for making contributions/donations.
Are there fees?
Yes, there are. And the fees are noticeable. Fidelity charges $100 or 0.6% as an administrative fee on top of the investment fees associated with the funds you select to use. Vanguard has similar administrative fees. If this is truly the greatest area of growth in charitable giving vehicles, my hope is that Fidelity, Vanguard and other providers will find a way to lower the fees for these accounts as they have with investment accounts to make them more attractive to open and maintain.
What do you get at tax time?
Another benefit of giving through a DAF is it is easier at tax filing time. You have less work to round-up receipts from your donations because you get one statement from your DAF record-keeper documenting the donations you’ve made that year and to whom. Remember, for taxable deductions – you are only concerned with documenting the money going in. The money going out to charities (your future donations) will not receive a 2nd tax write-off, but you may need to show that it went to qualified charities if you are ever audited.
Who can you donate to?
If you were thinking of something creative like donating to your own children to pay for college or something like that, sorry – this is not that kind of opportunity. You may only use the DAF to support IRS-qualified public charities.
RMDs – withdrawals after 70.5
And while we are talking about donations, don’t forget that if you face the interesting dilemma of being required to take more money than you need from pre-tax retirement accounts in your 70’s, you can donate directly to charities to satisfy those Minimum Required Distributions. We may ultimately do this, but we’ll have 20 or so years after retiring before we deal with this option.
What To Read More From Other Bloggers?
Here are a few of our favorite blogger takes on opening DAFs and related Charitable giving topics:
Physician on FIRE: The Donor Advised Fund, a Smarter Way to Give
JL Collins: How to Give like a Billionaire
You don’t need a huge amount of money to start one. Remember the minimums we mentioned above. Some of these fellow blogger examples had lofty initial contributions of $100,000. Our initial deposit was far smaller, but we plan to keep adding to it while we are working.
That’s a run-down of our donor strategy. Fund the DAF now while our taxable earning is high. Continue to contribute to it during our final working years and manage it throughout our retirement by distributing the funds a-little-at-a-time. We will likely also find ways to give in non-monetary ways during early retirement, but having a preserved account just for this purpose feels pretty good and what many charities need most is money.
It was super easy to establish the DAF with Fidelity. If anyone is interested, we could do a short step-by-step post on the process… but you’ll need to come up with the contributions 🙂
Have you done this? Are you thinking about this? Have you identified any downsides or cons to opening a DAF?