Donor-advised funds (DAFs) are increasingly popular for charitable giving. DAFs enable individuals, families, or organizations to contribute to a third party that sponsors the DAF and then recommend how the funds are distributed for charitable giving. Giving a DAF as a gift is a great way to introduce someone to charitable giving and allow them advisory privileges about how it is used. As the donor of the DAF, you receive immediate tax benefits.

Contributing to a DAF on behalf of someone else can introduce the recipient to the benefits of charitable giving. The recipient gets firsthand experience in philanthropy, where they can recommend grants to charities of their choice over time. This flexibility offers a thoughtful approach to charitable giving, enabling the recipient to engage with causes that resonate with them and at a pace that suits them.

Let's say John wants to introduce his granddaughter, Emily, to charitable giving on her 25th birthday. He decides to give $1,000 to a DAF on her behalf. He contacts a reputable community foundation that administers DAFs and opens an account, contributing $1,000 to it. He then designates Emily as the advisor of the fund. Now, Emily has the advisory privilege to recommend grants from this fund to her chosen charities. Over the next few years, at her own pace, she recommends grants to different organizations working on causes close to her heart. This gift not only provides Emily with a tax-advantaged way to support her favorite causes but also helps her act on her values through philanthropy and community support.

DAFs have opened up strategic charitable giving to everyday people, not just ultra-high-net-worth donors. For those looking to donate to charity in a tax-efficient manner or provide a special philanthropic gift, DAFs are an accessible option.

What Is a Donor-Advised Fund?

A DAF is a registered 501(c)(3) organization that manages charitable donations for individuals, families, and other organizations. When you contribute cash, stocks, bonds, and other financial assets to a DAF, your donation is immediately tax-deductible. Your investments continue to grow tax-free within the DAF until your recipient advises how they should be distributed. However, while your recipient is an advisor over how the funds are used, the final decision is up to the DAF sponsor—usually a community foundation, single-issue nonprofit, or national nonprofit—as you officially relinquish control over the asset when you make your irrevocable donation.

One of the key advantages of setting up and giving to a DAF as a gift is that you can take the tax deduction in the current year, even if the funds aren't distributed until later. Your recipient has plenty of time to develop a philanthropic strategy and decide which causes and organizations will ultimately receive the funds.

The Tax Benefits of Donor-Advised Funds

The ability to deduct a donation now and advise on its charitable uses later makes it particularly advantageous to contribute to a DAF in years when you’ve received a windfall or have a lot of taxable income to offset. In fact, you can deduct up to 60% of adjusted gross income (AGI) on your federal taxes for cash contributions and up to 30% of AGI for appreciated securities that you donate to a DAF.

Although cash donations can offset a greater percentage of your taxable income, there are additional benefits to donating securities that have appreciated in value to a DAF. For example, let’s say you own a stock that you bought a while ago at a low cost basis and it has since surged. If you donate those shares to a DAF, you avoid paying the capital gains taxes you would have paid if you sold the stock, and you can take a deduction based on the current fair market value of the donation.

How To Set Up a Donor-Advised Fund as a Gift

Setting up a DAF as a gift is fairly straightforward. Here are the typical key steps:

1. Select a DAF sponsor. Research community foundations, financial institutions, or nonprofits in your area that offer DAFs. Consider factors like minimum account sizes, fees, and investment options.
2. Complete account applications. Work with your selected sponsor to fill out the necessary paperwork. This includes forms for setting up the account and advising on investments.
3. Make an irrevocable contribution. Contribute cash, stock, or other assets to fund your DAF. You can now claim this contribution as a tax deduction.
4. Assign advisors. For a gift, you usually put down that the recipient will have advisory privileges for the DAF, meaning they can recommend grants to charitable organizations. You can also put yourself down as another advisor to partner with your recipient.
5. Notify the recipient: Most sponsoring organizations give you a way to notify the gift recipient: a formal letter, card, or digital contact of some sort.
6. Invest the funds: The DAF's assets can often be invested, allowing them to grow over time. The recipient will be given options by the sponsoring organization about how this can be done.
7. Recommend grants. Once the account is open, your recipient can recommend grants to nonprofits. The sponsor will review and issue grants based on these recommendations.
8. Seek advice. If needed, you and your recipient can ask the sponsoring organization for guidance on causes, nonprofits to support, or the kinds of gifts to make based on the recipient's philanthropic goals.

With some planning and initial paperwork, you can establish a DAF to start tax-smart charitable giving. It takes some effort upfront, but the ongoing flexibility and tax benefits make it worthwhile for many donors, a gift that, through your recipient, will keep on giving.

Giving to a Donor-Advised Funds as a Gift

While it may not be the first gift that comes to mind, contributing to a DAF on somebody’s behalf could add something meaningful to their life by giving them financial resources to carry out charitable work.

Or, if you determine that a DAF makes sense for your own charitable goals and your tax situation, you may decide to give somebody the gift of directing the eventual distribution of your donations. This would involve naming the person as a donor advisor on your DAF account. DAF sponsors may allow several advisors on an account, so you can split the advisory responsibilities with your gift recipient or give that honor to several people.

Once your gift recipient is registered as a donor advisor, they can work with the DAF sponsor to distribute donations to the charitable organizations most important to them. While contributing to a DAF as a gift could be a great chance to teach a young person about philanthropy, the recipient must be at least 18 years old to be a donor advisor.

The Potential Pitfalls of Giving Through Donor-Advised Funds

While encouraging somebody through a DAF to engage with charitable causes could make a great gift, there are some drawbacks. First, whether you’re serving as donor advisor of the account yourself or you’ve given that responsibility to somebody else as a gift, once you’ve donated an asset to a DAF, it’s ultimately under the control of the sponsor.

In other words, if you give somebody the unique gift of naming them the donor advisor of a DAF, they will have input into distributing the funds to charity, but the sponsor maintains the final say. Gift recipients will be able to pursue their charitable interests. Still, their recommendations will be subject to the due diligence of the DAF sponsor as well as requirements about the types of organizations that can receive DAF donations.

Another potential drawback is that the donated assets can sit in the fund indefinitely. Using a DAF as a gift means that the donations could remain in the fund for an extended period if the person you’ve named doesn’t distribute them. That said, depending on how your contributions to the DAF are invested, any such delays could mean more time for appreciation and more money for charitable giving down the road.

Other Considerations

Besides potentially parking funds to sit idly, there are other risks when you contribute to a DAF on somebody’s behalf. You should first check the financial stability of the sponsoring organization. The bankruptcy of the National Heritage Foundation in 2009 reportedly wiped out 9,000 DAFs worth $25 million before the donors had a chance to direct the funds to their desired charities.

There have also been cases of DAF sponsors using money contributed by donors for things like golf tournaments or their legal fees. The policies and practices of the DAF sponsor you choose will affect your gift recipient’s ability to meet their charitable goals, so it’s important to do your research before you donate your assets.

Even if you work with a reputable DAF sponsor and are confident in your gift recipient’s ability to make a positive impact, fees are another detail to watch. DAF sponsors tend to charge relatively high fees for managing the charitable accounts, which can chip away at the amount that donor advisors have available to direct to their favorite causes. There may be hidden fees involved with DAFs, so it’s important to research them carefully. While these may be unavoidable—the DAF sponsor gains income from your charitable gifts by collecting these fees—these might not sit well with all donors.

The Bottom Line

A DAF is a tax-effective way to manage charitable giving. If you want to take advantage of these tax benefits while enabling somebody else in your life the opportunity to pursue their philanthropic interests, a DAF is an excellent idea. Although you officially give up control over the assets you donate, once you name your gift recipient as the donor advisor of the DAF, they can guide the distribution of charitable donations to the organizations important to them.