A donor-advised fund gives you more flexibility around charitable giving. Instead of deciding immediately which charities should receive your gift, you can contribute to the fund now and recommend grants later. This flexibility is one of the main reasons donor-advised funds are popular. Let’s look at the details of how a donor-advised fund works from start to finish.
What is a donor-advised fund?
A donor-advised fund is a charitable account held and managed by a public charity known as a sponsoring organization or donor-advised fund (DAF) sponsor. You contribute to the account while the sponsoring organization manages what you give. Then you recommend grants from the account to charities over time.
Once you give the money, it belongs to the sponsoring organization, not to you. You retain what is called “advisory privileges.” This means you recommend where grants go, and the sponsoring organization approves them. In practice, sponsoring organizations generally approve recommendations that meet applicable law and the sponsor’s grantmaking policies. However, the money is no longer yours to take back. It is important to note that a donor-advised fund is not a savings account you use for giving.
A donor-advised fund is also just one of several charitable fund structures, and it is not always the right one. To compare it with alternatives, start with an overview of charitable fund types.
How does a donor-advised fund work?
A donor-advised fund works in three stages. You contribute to the fund, the assets are held and invested, and you recommend grants to charities. These stages can be spread out over years. Let’s take a closer look.
The Contribution
You start by contributing money or other assets to the fund. Once you make the contribution, the sponsoring organization has legal control of those assets, so you cannot simply take the gift back. You may also be eligible for a charitable income tax deduction for the year in which you make the contribution, even if the money is not granted to charities until a later year. That timing can make donor-advised funds particularly useful for people who want to make a larger charitable contribution during a higher-income year.
How much you may be able to deduct depends on a few factors:
- What you give
- How much you earn
- Overall tax situation
The rules are also different for cash gifts than for other kinds of assets. This is worth discussing with your accountant or financial advisor since the answer is specific to you.
The Holding Period
Once your contribution is in the fund, it can be invested and may grow over time. Any growth isn’t taxed to you, because the assets are no longer yours. If the fund grows, there is simply more available to grant out later.
You don’t have to empty the fund quickly. You can recommend grants the same month you open it, or let the balance sit while you think about where it should go. Many people use this stretch to plan their giving with more care than they would if they were writing checks at the end of December.
The Grants
When you’re ready to give, you recommend a grant to a charity. The sponsoring organization reviews the recommendation, confirms the organization is a qualified charity in good standing, the grant follows the sponsor’s policies, and then sends the money.
Sponsoring organizations must ensure every grant serves a charitable purpose, so they check each recipient before releasing funds. Sponsoring organizations generally approve recommendations that meet applicable law and the sponsor’s grantmaking policies.
The Simple Steps of Setting Up Your Fund
Opening a donor-advised fund is a shorter process than most people expect. There’s no legal filing and no board to assemble. In most cases, it comes down to choosing where to open the fund and making your first contribution.
1. Choose a sponsoring organization.
Community foundations and large financial companies both sponsor donor-advised funds, and while the funds work the same way, the organizations don’t. A community foundation will generally know the nonprofits in its region and can tell you who is doing good work on a particular issue. National providers may offer different minimums, services, or investment options, while a community foundation adds direct knowledge of the region it serves.
2. Ask about minimums and fees.
Sponsors set their own minimum for opening a fund, and they charge an administrative fee for managing it, usually as a percentage of the balance. Both vary widely. Ask directly, and ask what the fee covers.
3. Sign the fund agreement.
This document creates your fund. It names the fund, which can be your family name, your business, or the name of someone you want to honor. It also records your advisory privileges and lets you name successor advisors, meaning the people who will recommend grants after you.
4. Make your initial contribution.
You can start with cash or with appreciated assets like stock. The contribution establishes the fund and is what may make you eligible for a deduction in that tax year.
5. Start recommending grants.
Once your contribution settles, you can begin recommending grants, subject to the sponsoring organization’s policies. Donor-advised funds generally do not have a required annual distribution amount, although sponsoring organizations may have their own fund policies.
Making Gifts and Recommending Grants
Once your fund is open, two things happen. You add to the fund when it makes sense for you, and you recommend grants when you know where you want the money to go.
What You Can Contribute
Cash is the simplest option and the most common way people open a fund.
Many sponsors also accept appreciated assets, such as publicly traded stock. If you own stock that has grown in value, giving the shares directly to the fund is generally treated differently than selling them first and donating what’s left. Selling appreciated shares may trigger capital gains tax on the growth. Giving the shares to a charity may allow the donor to avoid recognizing that tax and may qualify for a deduction based on the share’s fair market value, subject to applicable tax rules.
The sponsoring organization performs due diligence on each recommendation. It confirms the recipient is a qualified charity and that the grant serves a charitable purpose. This is the part of the process you don’t have to manage, and it’s what your administrative fee covers.
A grant from your fund can’t provide you with more than an incidental benefit. For example, that means a donor-advised fund can’t buy your table at a nonprofit’s gala or cover the portion of a ticket that gets you dinner. The money is committed to charitable use.
How Grants Work
When you’re ready to give, you submit a grant recommendation to your sponsoring organization. You name the charity, the amount, and whether you’d like the grant made in your name, in your fund’s name, or anonymously.
Grants go to qualified charities, which mainly means public charities in good standing with the IRS. Certain supporting organizations can also receive grants, though those come with extra requirements for the sponsor. You can look up whether an organization is currently recognized as tax-exempt through the IRS Tax Exempt Organization Search before you recommend a grant.
Why open a donor-advised fund at a community foundation?
You might open a donor-advised fund at a community foundation because the organization holding your fund also makes grants in your region and may recommend local nonprofits that align with your philanthropic intentions. National sponsors can process a grant to any qualified charity in the country, while a community foundation can also bring firsthand knowledge of organizations, needs, and opportunities in its region.
A community foundation is a public charity built around a specific area. It holds funds for donors in that region, makes grants to nonprofits there, and often runs its own programs. The staff managing your fund are the same people reviewing local grant applications and watching which organizations deliver and which struggle.
That knowledge matters when deciding where to give your money. If you want to support after-school programs or food access or mental health services near you, someone at a community foundation can tell you who is doing that work, how long they’ve been at it, and what they need.
Getting Started With a Donor-Advised Fund
A donor-advised fund is a straightforward arrangement once the pieces are laid out. You contribute, the sponsoring organization holds and invests what you give, and you recommend grants when you’re ready. What makes it useful is that those steps don’t have to happen at the same time. You can decide to give now and take as long as you need when deciding where the money should go.
If you’re in the greater Pottstown region, Pottstown Regional Community Foundation offers donor-advised funds along with several other charitable fund types. The Foundation makes grants across western Montgomery, northern Chester, and eastern Berks counties and has awarded more than $59.8 million in grants since grantmaking began in 2004, so it can help you find the local organizations doing the work you care about.
Frequently Asked Questions
How do I set up a donor-advised fund?
Choose a sponsoring organization, ask about its minimums and fees, sign the fund agreement, and make your initial contribution. Most sponsors will let you recommend your first grant as soon as the contribution settles. The whole process is usually shorter than people expect, since there’s no legal filing involved and no board to assemble.
What can I give to a donor-advised fund?
Cash and publicly traded stock are the most common contributions. Some sponsors also accept complex assets like real estate, closely held business interests, or private company stock, though these take longer because the sponsor has to evaluate the asset before accepting it. Not every sponsor handles them, so ask early if you’re considering something other than cash or stock.
Can I recommend where the grants go?
Yes. You submit a grant recommendation naming the charity and the amount, and the sponsoring organization reviews and approves it. The recommendation is technically nonbinding, since the assets legally belong to the sponsor once you contribute them. Sponsoring organizations generally approve recommendations that meet applicable law and the sponsor’s grantmaking policies.
Is a donor-advised fund better than a private foundation?
Neither is inherently better. A private foundation is a separate charitable organization with its own governance, filings, investment responsibilities, and grantmaking. A donor-advised fund is administered by a sponsoring charity while allowing the donor or appointed advisors to recommend eligible grants. The better fit depends on your charitable goals, resources, and how much administrative responsibility you want to take on.
Invest in Your Community
At Pottstown Regional Community Foundation, we’re dedicated to improving quality of life across the greater Pottstown region. We help donors give in ways that really make a difference and award grants to local organizations. The Foundation also funds and leads programs that serve our community. Contact us today to learn how we can work together.
