Charitable Gift Trusts
Not Just for the Wealthy
By Roy Lewis
Donor-advised funds (also commonly known as charitable gift funds, charitable gift trusts, or philanthropic funds) have been a hot topic in the financial press lately. Let's take a few minutes to see how you might be able to use such a fund to your tax advantage.
What's a Donor-Advised Fund?
In effect, donor-advised funds are simply tax-qualified public charities, similar to your church or synagogue, your alma mater, or any other public charity.
Very simply, making a contribution to a donor-advised fund will allow you to essentially set up your own charitable account, and then recommend (but not command) how the money will be doled out to various charitable organizations that you select. In effect, it allows you the opportunity to set up your own mini private foundation without the (considerable) cost of actually establishing a private foundation for yourself.
Once you make your request to funnel the money in your account to your favorite charity, the administrators of the fund will check out the charity to make sure that it is qualified under the IRS rules and regulations. If the charity checks out, the fund will then make the requested contribution to your charity.
Once you make a contribution to the donor-advised fund, the fund handles all of the administrative aspects of the fund and distributions. Until your account is completely spent, it earns income and can continue to grow tax-free. And, some funds allow you to advise contributions as low as $250. Donor-advised funds associated with mutual fund companies and investment houses will allow you to designate how your account money is invested, giving you a choice of several investment pools containing various mutual fund alternatives.
Is this something new? No, not really. Donor-advised funds have been around for about 30 years, but they didn't become really popular until mutual funds and other investment folks became interested in the concept. You've heard of Fidelity Funds, right? Well, the $2.2 billion (that's right... billion) Fidelity Investments Charitable Gift Fund now claims to be the largest grant-making organization in the U.S. In 1999, it reportedly gave out $457 million to various charities.
Fidelity isn't the only player in the game. You'll also find The Vanguard Charitable Endowment Program, The National Philanthropic Trust, Schwab Fund for Charitable Giving, and the Eaton Vance U.S. Charitable Gift Trust, among others.
Because donor-advised funds are qualified public charities, they offer a three-pronged tax advantage.
First and most obvious, your contribution to the fund is tax deductible as a charitable contribution. And, the contribution deduction is immediate... in full in the year that the contribution is made to the fund... even though the fund might not pay out any contributions to your recommended charities until months (or even years) down the line.
So, you can get an immediate tax deduction when you need it (in a big income year, for example), while the actual payouts from your account can be deferred until later. The account can grow tax-free in the meantime. Sweet. You can clearly see that the benefits of using a donor-advised fund as a year-end tax planning tool can't be overstated.
Second, contributing qualified appreciated stock to a donor-advised fund will allow you to claim the full fair market value of the stock as a charitable contribution, while avoiding any capital gains on the contribution. This also works for qualified appreciated mutual fund assets. This is a big selling point for donor-advised funds. Substantial contributions made to these funds come in the form of qualified appreciated stock and mutual funds.
Finally, the contributions that you make will reduce the value of your taxable estate.
So, when you review all of the tax advantages and control (both in the timing and the amount of contributions to your charities) that you'll have over your individual account, I'm sure that you can see why donor-advised funds have become so popular.
All of the advantages of donor-advised funds do come with some degree of risk, since there are no clear-cut tax guidelines for donor-advised funds as there are with public charities in general. You might have heard that the IRS is looking into the use of donor-advised funds as a charitable contribution vehicle... and it's true.
However, the proposed rules would only codify existing "best practices" in the industry. For example, it's possible that funds will be required to distribute some percentage of their total assets (like 5%) at least annually. In addition, the rules would clarify the fact that the fund must have the absolute and final say on which charities will receive contributions.
With all of that said, I find it simply impossible to believe that a donor-advised fund associated with a major mutual fund company or investment house would not be able to successfully defend itself against an IRS attack. You'll have to do your own research to determine if the risks outweigh the rewards. All I can say is that I've used these funds in the past, and have no problem sleeping at night. That's not an endorsement... simply a fact.
If you're interested in using donor-advised funds to reduce your tax bite, make sure to take a look at more than just one or two. Before you sign-up, pay special attention to the amount of the required initial contribution (normal ranges are from $10,000 to $50,000).
You'll want to take a look at the management fees you'll be charged. Virtually all donor-advised funds will charge some type of fee, normally equal to a percentage of your account balance. These fees could range from 0.57% to 0.7% (Schwab, Fidelity, and Vanguard), to 2% and above (Eaton Vance).
You'll also want to determine the minimum amount that you can contribute to your specific charity. So, make sure that you read all of the small print before you make your final selection, and then select the fund that works best for you.
If you have a charitable streak in you (and you really should, if you're a true Fool), you might have found the next best thing to creating your own private charitable foundation in the use of a donor-advised fund.
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