Donor-advised funds, or DAFs, have been growing robustly right through the economic slump, and they're now becoming much more well-known as vehicles for charitable giving. My Fool article "Donor-Advised Funds: The Basics and Benefits" will give more background on them. Despite their popularity, DAFs require a bit of research and ongoing work to perform well

Here are some tips to avoid problems and mistakes before you decide to establish a DAF.

Choose a sponsor carefully
You have many choices of sponsor organizations. Each has different restrictions, levels of service, and fee structures. Choosing a sponsor organization takes time and research. It's worth the effort to find the right match for you, especially if you are planning to hold the DAF for a long time or engage other family members in the fund.

Although all sponsor organizations must have an IRS nonprofit status, some commercial DAF sponsors may not provide support after the fund is set up. Some sponsors have limited ability to:

  • Help you identify your philanthropic priorities.
  • Provide direct knowledge about nonprofit organizations or how to assess them.
  • Support intelligent grant-making.
  • Gain reports to measure results.

If you want the sponsor organization to provide those services, make sure they are qualified to do so and find out what charges are associated with that service delivery. Alternatively, you may want to gain this range of support using an independent philanthropy coach.

The sponsoring organization controls the fund's investments. Some sponsor organizations give you a prescribed list of investment options; others do not offer a choice. If you want to manage the investments yourself, your options may be limited.

Frustration

Source: Flickr user Andrew McCluskey

All asset transfers to the fund are irrevocable. If you have a windfall or other circumstance that prompts you to set up a fund, you might size the fund based on certain donation amounts in future years. That may not hold true if your financial situation unexpectedly changes. Once the gift is given, you will have to live with that decision into the future.

If you have charities that you know you want to benefit through the fund, make sure that those nonprofits are approved by the fund's sponsor. Once you set up the fund, you "advise" the organization on the gifts to make; the sponsoring organization is actually in legal control.

Transferring a donor-advised fund from one sponsor organization to another may be difficult or impossible. If you are unhappy with the sponsor organization, your options may be limited. Do the work to find the right sponsor organization at the outset. Also ask about the capability to transfer.

Making grants from your donor-advised fund
Using donor-advised funds involves three phases, so be prepared to spend time on all three. You will need to select a sponsor organization, create the fund, and then recommend charitable gifts out of the fund. If you don't understand this final set of actions, your fund may not fulfill its purpose.

You are only eligible for the tax deduction once -- when you transfer assets to the fund, not when the donations are made to nonprofits out of the fund. This means that, due to market fluctuations, the value of your original contribution to the fund can be greater or lesser than what is available for grants to nonprofits.

You may be limited in the grants that can be made out of the fund. Some sponsor organizations restrict the amount that can be made outside of a geographic area. Most funds make grants only to domestic nonprofits. However, there are options if you want to benefit overseas organizations, such as Charities Aid Foundation of America, FJC Foundation, or the National Philanthropic Trust.

No donation made from a donor-advised fund can be made if goods or services are received as a result of the gift. For instance, if you bid on an item at a charitable auction, you cannot fulfill that charitable commitment from your donor-advised fund.

With these cautions in mind, donor-advised funds can be a great tool for donors to increase their philanthropy -- and make it smarter.