DAF Series Part #2: Debunking myths
Updated: Oct 15
It can be hard for people to make the decision on whether or not to use a Donor-Advised Fund (DAF) because the resources out there are few and far between and quite frankly, misleading. Most of the DAF information I see out there comes directly from marketing and sales materials from the providers themselves. DAFs are super useful, but they do often get overhyped, largely in terms of their tax benefits.
I just did a quick Google search of “Should I open a DAF?” to see what comes up. The top 3 DAF providers are highlighted on the first page of search results. Here are their taglines:
“Maximize your tax efficiency and charitable impact with a giving account”
“Maximize your impact with a Giving Account— the tax-smart way to donate to your favorite charities”
“Structure your charitable giving with a simple, tax-smart investment solution of a donor-advised fund account.”
Yikes! Seems like they’re all using the same marketing agent…
As discussed in our previous post, DAFs certainly do have tax benefits, but they tend to be blown way out of proportion. If you walk away with any sense from this post, remember these two things:
Contributing to a DAF does not automatically mean you get tax savings
Using a DAF is not the only way to obtain tax savings when donating to charity
Ok! Let’s debunk some myths shall we?
Myth #1: You need a DAF to get an upfront tax deduction on your donations
Not true! Whether or not your charitable donation is tax deductible is totally dependent on whether or not you have met or exceeded standard deduction in any given tax year (in 2023, it is $13,850 for single filers and $27,700 for married filing jointly). Lowering your taxable income via deductions is not dependent on having your money in a DAF. For example, you could (A) donate cash directly from your checking account, (B) donate stocks from your brokerage account, or (C) make a contribution to your DAF. In all three of those instances, you would be able to lower your taxable income if you meet or exceed the standard deduction and choose to itemize your deductions instead. You don’t need the DAF to do this. P.S. If you need a refresher on the standard deduction, see this post on Charitable Tax Breaks.
Instead, the real benefit of a DAF is that you can make a large charitable contribution in one year, reap the benefits of a tax-deduction today, but still maintain the flexibility to slowly make charitable grants over time. This is the only type of account that allows for a delay in the actual grantmaking process. And this is a real benefit for many who are not quite ready to make all their donations today! But unfortunately, I just don’t think this is explained well in most materials. Ultimately, I don’t think DAF providers are intentionally trying to be misleading. I know it’s just a little too complicated to try and explain all this when you are trying to sign up for an account. But it shouldn’t be as opaque as it is today to understand this basic concept!
💡Another thing worth noting: Charities will often market to you and say “Make your tax-deductible donation today!”. This is another misleading tagline! The same concept applies here. That donation is not tax deductible unless you donate above and beyond the standard deduction and choose to itemize on your taxes.
Myth #2: DAFs are the only way avoid capital gains taxes
Again, wrong. Yes, it is true that when you invest in a DAF, the gains within that account are not subject to tax. However, this is also the case if you choose to donate appreciated stocks directly to charity without using a DAF. In fact, this is the exact donation approach I take. Rather than liquidating (or selling) stocks from my regular brokerage account to make donations, I just go ahead and donate these stocks directly to my charity of choice. In this way, I still avoid capital gains tax without having to do the extra step of contributing to a DAF. The charity itself can choose to hang on to the donation in the form of a stock and keep it invested, or it can liquidate it to use the funds today. And in great news, since the charity I donate to is a 501(c)(3) organization, it will not face capital gains tax. In other words, I’m not pushing my tax burden onwards.
I like this model because I still get the tax benefits, but I’m not donating quite enough money that I feel the need to extend my donations over time. I’m happy to make those donations today. Of course, the qualified charity receiving the donations must have a way to accept securities, but most established 501(c)(3) organizations do this.
Here’s a prime example of misleading marketing. Charles Schwab wants to show us that donating via a DAF eliminates the burden of capital gains tax, but they make it seem like it’s the only way to do that.
Here they show Option 1 is to sell appreciated stock and then make a donation, which of course results in a taxable event. Then they show Option 2, donating via a DAF, to avoid this tax burden. This frustrates me. It’s not the DAF that helps avoid the capital gains tax, it is the not selling part that avoids this! You could easily have an Option 3 that says “Donate stock directly from your brokerage account”...the tax savings would be the exact same.
Myth #3: DAFs are the only way to invest charitable funds
Similar to the previous myth, there are other accounts that enable you to do this. You can donate stocks, bonds, funds, and ETFs from both your regular brokerage account and your IRA without incurring penalties or taxes. While they are not charitable specific accounts, they still allow for account growth and donations!
The converse argument here is that DAFs will automatically liquidate funds for you when it comes time to make charitable grants. So they are one of the best ways to invest and liquidate funds for charity without facing capital gains tax.
Make sure to download Yield & Spread’s Giving Guide to compare and contrast these accounts.
Myth #4: DAFs allow you to donate more money because your investments will grow
This isn’t necessarily a myth, but it isn’t necessarily true either.
First, whenever we invest, we face a risk that the value of our investments do not go up, especially if we are trying to pick winning stocks or mutual funds that outperform the market. If you contribute to a DAF and plan on making grants over the next year, the market could easily drop in that timeframe and the value of your investments could be lower than your cost basis (what you originally paid for). In the Learn to Invest course, we don’t advise students to invest their money unless they are in it for the long run so they have time to ride out the ups and downs of the stock market. The market always rises, but it’s on average and over a long period of time. The same applies to a DAF. If you plan on contributing to one, then only investing your money for, say, 6 months before making your donations, just be aware that there is a real risk the value of your investments could drop.
Secondly, you could make crummy investment choices! Even if the overall market goes up, you may end up investing in a fund that underperforms comparably. It’s for this reason, I still advocate for investing in low-cost, highly diversified index funds to minimize your risk and follow the overall market trend. A quality DAF provider with integrity should allow for this.
Lastly, remember there are administrative fees associated with using a DAF! Your investment growth has to outweigh the fees that come with using a DAF. If you’re working with a thoughtful provider, then the fees will on the whole be low, but they are still there. So if you see a 0.6% annual banking fee, just remember your investments need to grow such that they outpace the fee to make a DAF worthwhile.
Make sure to check out the next post to determine whether or not a DAF is right for you!
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