Dr. Disha

Mar 218 min read

Step by Step Guide to Opening a Donor Advised Fund

Hi friends,

It has been a while since I have written a blog post. I hope you have been enjoying the podcast that we recently launched!

My goal is to keep writing more, so let’s go!

As you know, my family and I worked hard to pay off $208k of student loan debt in 17 months. Then, we saved up a good 6-month emergency fund and a downpayment for our the home we purchased in 2020, all the while growing our investments in the stock market and real estate.

Soon, we made it into the double comma club and started thinking about how we could give back to the community more meaningfully.

We had been making small donations here and there all along.

Recently, we started making larger donations to support the local arts and talked to our accountant about how we could take full advantage of our charitable donations for tax purposes.

That’s when we started thinking about donor-advised funds.

We finally opened one and this post will show you how to do it step by step!

But first, what are donor advised funds anyway?

Donor advised funds (DAFs) are vehicles for charitable donations that have increased in popularity recently. These funds allow the donor to donate cash or assets such as appreciated stocks, bonds, and index funds, from a brokerage account.

Thus, the capital gains on those appreciated assets are not amassed as the assets are donated to charity. Additionally, large sums can be donated in one tax year, but donations can be distributed at any time in the future. The funds can then be reinvested and grow tax-free until they are donated.

Why would you want to invest in a DAF?

The COVID-era tax write-offs are a thing of the past. Now, to take advantage of tax breaks offered by charitable donations, we have to itemize our returns.

However, itemizing returns only makes sense if the deductions from itemizing actually exceed the standard deduction, which is quite large.

For the last few years, even though we made charitable contributions, we still didn’t exceed the standard deduction.

The advantage of a donor-advised fund is that a lump sum can be donated to the DAF at once, and then that sum can invested and donated slowly in the years to come, in smaller amounts.

But, we can take the tax deduction for the lump sum donation in the year of the contribution to the DAF, which would result in a tax benefit if we itemized.

For example, our accountant told us that it would only make sense to itemize for donations if we donated greater than $10,000 in one year. Our financial plan involved donating around $4,000 a year. Therefore, we decided to use a DAF to help us maximize our tax benefit.

Instead of making three $4,000 donations in three years without getting any tax benefit, we would donate $12,000 in year one to the DAF and then make those $4,000 donations from the DAF in subsequent years, while taking credit for the $12,000 donation this year and lowering our taxes.

Also, the rest of the money not donated this year continues to be invested in the DAF and continues to grow until it is donated.

In this way, not only can we get some tax optimization by itemizing, but we can also flush out the capital gains from our brokerage account.

Win-win for all.

You’re probably thinking but there have to be some IRS limitations to this right? You’re right. You can only deduct up to 30% of your adjusted gross income in any given year if donating investments and up to 60% of your adjusted gross income if donating cash.

For doctor incomes, these limits can still result in very sizable donations and deductions. Any donations that exceed the AGI limits can be carried over for up to five years. [1]

So to summarize, here are the pro’s and con’s of DAF’s:

Pro’s:

Tax Benefits: One of the primary advantages of using a DAF is the immediate tax deduction upon contribution. Donors can claim a tax deduction for the full donation amount in the year they contribute to the DAF, even if the funds are distributed to charities over several years.

This strategy is called bunching.

The charity can benefit by getting the full value of shares donated, including their appreciation, tax free. [2]

Simplicity and Flexibility: DAFs offer donors a streamlined approach to charitable giving. Once funds are contributed to the DAF, donors can recommend grants to charities throughout the years to come. This allows for flexibility in timing and distribution of charitable gifts and ease of accounting. No more tracking down and storing receipts for small donations.

Investment Growth: DAFs typically allow donors to invest their contributions, potentially allowing the funds to grow tax-free. This can result in larger charitable contributions over time, maximizing the impact of the donor's initial gift.

Anonymity: Donors can choose to remain anonymous when making grants from their DAF, providing a layer of privacy and discretion in their charitable giving.

Legacy Planning: DAFs can be a useful tool for individuals looking to involve their family in philanthropy and create a lasting charitable legacy. Donors can appoint successors to continue recommending grants from the DAF after their passing, ensuring ongoing support for causes they care about.

Con’s:

Fees: DAF’s usually have fees associated with them. They usually have minimum annual fees or fees based on a percentage of contributions. The investments themselves also have expense ratios to look for. These vary from institution to institution. See the latest fees and minimums for the most popular DAF’s in next week's article.

Limited Control: Once the assets are donated are in the DAF, they are no longer yours and cannot be taken back and used for personal purposes. Also, while donors can recommend grants from their DAF, they do not have direct control over the assets once they are contributed. The sponsoring organization of the DAF ultimately has discretion over approving grant recommendations.

Minimum Contribution Requirements: Many DAFs have minimum contribution requirements, which may limit access for smaller donors.

Investment Risk: While the potential for investment growth can be advantageous, it also comes with inherent investment risk. Donors should carefully consider the investment options offered by the DAF and understand the potential for loss.

Lack of Immediate Impact: Unlike direct donations to charities, contributions to a DAF may not have an immediate impact on the organizations or causes supported. Funds contributed to a DAF may be invested or held for future distribution, delaying the benefit to charitable recipients.

Perception of Disconnection: Some critics argue that DAFs create a sense of disconnection between donors and the charitable organizations they support. Because donors can remain anonymous and have limited interaction with the beneficiaries of their donations, there may be less accountability and personal engagement in philanthropy.

For us, the DAF was the right way to go. We chose the Fidelity DAF because of its reasonable fees, low donation minimums, and ease of use because we already had other accounts there. However, our brokerage account is actually at Vanguard.

The fear of the process is what keeps a lot of us from taking the next step or opening the next account. So I thought I’d give you a step-by-step view of the process of opening, funding, and giving from a DAF at Fidelity and funding it from a Vanguard brokerage.

Opening the DAF:

Go to fidelitycharitable.org and click on “Open a Giving Account” and you will come to this screen. Click on “Open now.”

2. Next, you’ll be asked for basic information regarding the account holders.

3. Fill out the account information, confirm and submit and your new DAF is up and rolling!

4. Next, we have to fund our account. Click on “Fund Giving Account.” We funded ours with index funds with capital gains in our brokerage account at Vanguard.

5. We picked a non-fidelity account and proceeded. The next screen asks for our delivering firm information (Vanguard for us) along with the account number. Enter that in, click next.

Here you’d select what security you want to contribute (stock or mutual fund). You’ll need to know how many shares you want to contribute. This will require some calculation.

6. Start with the total amount you want to donate, then look up the price per share of the security. Then divide the total by the price per share and round to the nearest share. Enter that, and then hit next.

7. Next, it will ask you how you want your DAF contribution invested. There are three options- the first is basically target date funds. The second (customized strategy) is where you choose your own investments. And the third is a collection of green investments.

Here are the investment options:

For Option 1: You see good investment returns but high expense ratios in my book.

Option 2: You can choose your own asset allocation of broad-based index funds. There were more options pictured here. This is the option I chose and invested in low expense ratio, decent return broad-based index funds. I chose an aggressive strategy (90% domestic stock, 10% international stock).

Here is Option 3.

Next, it will have you print out the “letter of instruction”, sign it, and, mail or fax it.

A couple of pro tips here. The letter of instruction will have a space where you can specify the lots to sell. I highly recommend you do this to sell off the shares with the most long-term capital gains so you can flush them out of your brokerage account (see below on how to find that out).

Note, You must have owned an asset for at least a year to deduct the value of the asset at the time of the donation. If you owned the asset for less than a year, you can only deduct the cost basis (or what you paid for it).

To see your investments and their capital gains, you’ll have to go into your brokerage account and specify the cost basis method for your investment. To do this, click on Portfolio on the main top toolbar and scroll down to “Cost Basis.”

Then click on “change cost basis method” under your brokerage account. You want to display it as “specific identification" (specID).

To view the specific lots and their capital gains, click “Show lot details” under the name of the holding. You’ll be able to see each lot that you bought, what date it was bought, and how much short and long-term capital gain (or loss) has been totaled since you’ve owned it. Donate the shares with the most capital gains.

To do this, simply write in the lot acquisition date and lot acquisition cost of the shares on the letter of instruction to fidelity in the space provided.

Then, you can mail or fax it. OR you can call Fidelity Charitable and they’ll give you an email address to scan and email it to. They only check it when you tell them you’re sending it, so you’ll need to call for the email address. Once that’s done, sit back and wait a few days for the transaction to go through.

How to Donate from Your Donor Advised Fund

Once the funds have been deposited, you can go in and donate them or let them sit and earn more until you’re ready to donate them.

To donate, log into fidelitycharitable.org and click on “Make a grant.”

Then, simply search your charity by name or Tax ID. Enter in the amount to grant, click “Add to List.” Then click “Next Step.”

Then it will ask you how you want your grant to be funded. You can just pick “quick allocation” if you want to keep the same percentages as your asset allocation.