Donor-advised funds are tax-preferred investment accounts established with a public charity. They allow donors to receive an immediate tax deduction when making the initial charitable contribution to the fund, with the final grant of the fund’s assets to be made separately at a later date.

Normally, donor-advised funds are sponsored and operated by a charitable organization that is tied to a larger financial services firm or a national nonprofit. The largest sponsors of donor-advised funds are the Fidelity Charitable, National Philanthropic Trust, Schwab Charitable, Goldman Sachs Philanthropy and Vanguard Charitable, all holding more than $2 billion. Sponsors are required to be registered 501(c)(3) nonprofits.

Recent years have seen the popularity of donor-advised funds grow significantly. According to the National Philanthropic Trust’s annual Donor-Advised Fund Report for 2022, total grants to charities made through donor-advised funds increased by 28% year over year to $72.67 billion in 2021, an all-time high and far above the 10-year average growth rate of 18%. This unusually high amount compares to the second-highest annual rate of growth as recorded by the National Philanthropic Trust of 35% in 2012. Economic conditions pushed donors to favor an immediate tax benefit by contributing to donor-advised funds both in 2012 and 2021.

Regardless of the specifics of recent years, donor-advised funds still have a long-term trend of increasing in popularity. This trend stretches back to their first formal legal recognition in 2006 via the Pension Protection Act. The history of donor-advised funds goes all the way back to their creation in the 1930s.

Advantages of Donor-Advised Funds

Contributions to a donor-advised fund are irrevocable and eventually required to be donated to an eligible charity. This makes contributions tax deductible up to a limit of 60% of adjusted gross income (AGI) for cash gifts and 30% of adjusted gross income for noncash assets (50% in certain instances). Because the main benefit of a donor-advised fund is to receive an immediate tax deduction without committing contributions directly to a charity at the same time, the overarching strategy for the use of donor-advised funds is when a large amount of income is expected that would spike income taxes. Investments within a donor-advised fund grow tax-free.

Regarding the years with a large growth in contributions to donor-advised funds, 2021 capped off the bull market that followed the initial coronavirus pandemic–induced bear market early in 2020. The S&P 500 index returned 28% in 2021, following 2020’s return of 16%. Contributions to donor-advised funds can be effectively used to front-load tax deductions in a year when a higher tax bracket is expected, garnering the highest impact for tax deductions.

Considering the returns of the market, another advantage of using a donor-advised fund is the ability to contribute appreciated noncash assets, such as shares of stocks, mutual funds and exchange-traded funds (ETFs). This also comes with a higher percentage of adjusted gross income that can be donated: the limit for donating assets to a private foundation is 20% of AGI, compared to the limit of 30% of AGI for donating assets to a donor-advised fund. This is one way to deal with the potential capital gains of an appreciated noncash asset because these contributions are appraised at the fair market value. Also, smaller charities may not have the ability to accept investment assets as gifts, lacking the structure and accounts to do so. With a donor-advised fund, noncash assets can continue to grow tax-free before liquidation for a grant.

Other advantages related to donor-advised funds include anonymization and creating a long-term legacy fund that allows an evaluation of charities over time. Because an immediate tax deduction is recorded when contributions to a donor-advised fund are made, there isn’t a need to attach a name to the eventual donation when it occurs if the donor is interested in remaining anonymous. The fund’s sponsor isn’t required to disclose the details of the ultimate donation’s source.

Because a donor-advised fund can receive contributions from multiple sources, the fund can act as a long-term shared giving vehicle even after the initial donor who opened the account passes away. If you are unsure of where you want your donations to go, the fund gives you the flexibility to let investments continue to grow and leave the grant decisions to your descendants.

Differences in How Donor-Advised Funds Work

Contributions to a donor-advised fund remain at the control of the donor for the most part. Technically, a donor-advised fund doesn’t have to adhere to specific guidelines from the donor on how to invest fund assets or to which charity grants are eventually made. In practice, though, much freedom is granted to donors to maintain oversight. This is especially true for the largest sponsors of donor-advised funds. They have the resources to maintain easy administration at efficient costs.

That being said, investment options do vary by the institution sponsoring the donor-advised fund. Vanguard Charitable only allows investment into Vanguard mutual funds, as an example. This is the case for the other largest sponsors previously mentioned: Fidelity, Goldman Sachs, Schwab and the National Philanthropic Trust.

For eventual donations, the main restriction is that the grants are made to charities in good standing with the U.S. Internal Revenue Service (IRS). It is common for a donor-advised fund to stipulate a minimum annual grant, but the amount is typically small, varying from $50 at Fidelity and Schwab to $250 at the National Philanthropic Trust and Goldman Sachs to $500 at Vanguard.

Other considerations for choosing a sponsor are the minimum initial donation amount for the account, minimum subsequent annual contributions, administration fees and the minimum amount in the account to qualify for adviser assistance.

You could also set up an account through other donor-advised fund sponsors, such as community foundations or religion-affiliated organizations. Investment options are often more limited with smaller sponsors. However, local or specifically focused charitable organizations may be better suited to knowing where grants should ultimately be directed, better executing their missions.

Before a specific donor-advised fund sponsor is selected, you can compare the donor-advised funds to the most similar alternative for charitable giving that allows separation between the initial contribution and its eventual donation, which is private foundations. Principally, the limitations on the allowed tax deductibility of cash and noncash contributions as a percentage of AGI are lower for private foundations than for donor-advised funds. Private foundations are also more expensive to operate than donor-advised funds and held assets may face a tax on investment income. Private foundations are best for specific scenarios where the desire is to make grants to individuals where permitted, to retain greater control over the assets and their investment or to compensate particular people in a management role.

Conclusion

Donor-advised funds allow donors to take an immediate tax deduction on their contributions now without the need to decide at the same time where the funds will ultimately be gifted. The benefit of receiving a tax deduction now is that any cash or noncash contributions are committed to the fund and cannot be removed. Eventually, everything in the fund will be donated to a charity in good standing with the IRS. Donors maintain control to an extent over how the assets are invested to grow tax-free in the donor-advised fund and which charitable organizations receive grants. Donor-advised funds are most comparable to private foundations but have the advantages of less overhead and better tax deductions.

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