Giving Is Good; Giving With a Donor-Advised Fund Is Better

A donor-advised fund (DAF) is an excellent and tax-efficient way to give to charity. The vast majority of my charitable giving is to and from my DAF. There are several big advantages to using a DAF as opposed to giving cold, hard cash, or writing checks.

1. You get a tax deduction in the year that you donate to the fund that you control.

2. You can give from the fund to charities of your choice years later.

3. You can donate equities that have appreciated and nobody owes capital gains tax.

4. Your donated money can remain invested in index funds.

I started my first DAF several years ago when I had large capital gains and wanted to bring my taxable income down. I had some T. Rowe Price funds that had sizeable gains and I donated them to start my DAF with the T. Rowe Price Fund for Charitable Giving.

A couple years later, as I learned more about investing and fees, I realized I would probably be better off keeping my dollars with Vanguard. So I moved my taxable account to Vanguard and my DAF to Vanguard Charitable. When I realized that the minimum grant from Vanguard Charitable was $500, I opened another DAF with Fidelity Charitable, which allows donors to give as little as $50 at a time.

One of my biggest hang-ups with the concept of an early retirement is the fact that I'm giving up the potential to continue earning money that could be used for the greater good.

I should have more than enough for my family and I when I retire, but if I kept working, great things could be accomplished by donating those future earnings. I'm not talking Bill Gates or Warren Buffett kind of money, but $10,000 here and $20,000 there could make a palpable difference locally.

I plan on using my DAF to eliminate that hang-up. I treat it a lot like I treat my retirement nest egg. I will keep working until it is large enough to satisfy my desires. Currently, my DAF balance is about 5% of my nest egg. I'd like that to closer to 10% at retirement. I don't think I will walk away feeling the least bit guilty if every 10th day's income ended up going to charity.

When donating appreciated mutual funds, as I do, you are limited by IRS rules to giving 30% of your adjusted gross income in any given year. My current plan is to wait a few years until my taxable account (hopefully) has some decent capital gains, then start super-funding my DAF with close to 30% of my income each year for several years until I reach my goal, donating the funds that have the largest capital gains.

Doing the most good

I also plan to donate half of any proceeds from my website to my DAF as part of its charitable mission. When the DAF is fully funded, I will continue to treat it like a nest egg, donating around 4% or 5% per year, perhaps more when market returns are good. I should be able to make it last indefinitely if I'm careful, and I can give big with what's left towards the end of my time on earth.

How much does it cost to put $100,000 into a DAF? This is not a trick question, but it does depend on your marginal tax rate. If you live in a state with state income tax, at a dentist's salary, your marginal tax rate is probably in the 35% to 50% range. Donating $100,000 will reduce your tax liability by $35,000 to $50,000.

If you are donating appreciated mutual funds like me, you will avoid capital gains (15% or 20% plus state income tax plus 3.8% Medicare surcharge for most of us). If the $100,000 donation has a cost basis of $50,000 (you bought in 2009 and the fund has doubled), you're saving about 25% of the $50,000 gain by avoiding the capital gains, so that's another $12,500 saved.

So… how much does it cost? It depends on the situation, but for me, it costs about $60,000 to donate $100,000, and that's without factoring in the potential savings in capital gains.

Are there drawbacks to using a Donor-Advised Fund? Sure. You can't take it back. A card laid is a card played. As with any charitable giving, once you give, the money is no longer yours.

You will retain the ability to direct where the money goes from your fund as long as it goes to a bona fide charity. Also, there are minimum donations to open an account, and minimum grant amounts when you give from your fund. If you go years without giving at all, the Fund can choose to donate for you. If the parent company goes belly up, the money could go with it (this happened to the National Heritage Fund in 2009).

Another drawback that deserves mention is that building up a DAF as I plan to do will obviously delay your retirement, or at least delay reaching your retirement goals. It will take me an extra year or longer to reach my goal numbers for an early retirement, because I will be diverting funds to charity. It's a choice that I believe will make me feel more comfortable leaving the medical profession before my 50th birthday.

As I mentioned above, I now have two DAFs. The Vanguard Charitable Fund makes it easy to transfer funds from my taxable account to my giving account. I have a Fidelity Charitable account so that I can make grants as small as $50. Both have a variety of investment options with low fees, and make it easy to make grants when you wish. Both have an additional annual expense of 0.6% (or $100 with Fidelity, whichever is lower). This is comparable to the tax drag one would see if the money were kept in a taxable account (2% dividends taxed at 30% = 0.6%).

In summary, giving is good, but giving to and from a donor advised fund is even better. To stretch your donated dollar as far as possible, look into starting one of your own.