Charitably Minded

Tools for the Charitably Minded: Donor-Advised Funds and Charitable Remainder Trusts

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Each person’s relationship with charitable giving has an origin story. Maybe it was when your grandmother would cook dinner for people in your community who were less fortunate. Or you were required by parental contract to give up a certain percentage of your allowance to the church collection basket.

No matter how it started, now you’re grown and you are still a charitably-minded individual who wants to give to causes you care about. You’re not the only one.

Charitable giving, giving back through volunteering and donations soared during the COVID-19 pandemic, as exemplified by these statistics:

  • 88% of affluent households gave to charity in 2020 (according to Bank of America and the Indiana University Lilly Family School of Philanthropy).
  • Americans gave $471.44 billion in 2020, up 5.1% from 2019 (according to the National Philanthropic Trust).
  • Giving in every sector increased, but especially gifts that benefit the public/society (up 15.7%), the environment and animal rights (up 11.6%) and individuals (up 12.8%) (according to the National Philanthropic Trust).
  • 86% of affluent households maintained – and in some cases increased – giving, despite uncertainty caused by the pandemic (according to the National Philanthropic Trust).

If you are part of this increased giving trend – or want to be – among the tools available to you for your charitable giving are donor-advised funds and charitable remainder trusts.

While both of these tools play a role in charitable giving – in that they both provide long-term resources for charitable causes – they are quite different.

We’ll give you an overview of both, when they might be the appropriate choice and some tips for getting started with each.

Deeper in the DAF

A donor-advised fund (DAF) is a tool that can help you maximize your charitable giving. Essentially, you make an irrevocable contribution to the DAF of either cash or other assets, like appreciated securities. While there is no startup cost associated with a DAF, the initial contribution with some DAFs is at least $5,000.

The DAF is sponsored by a 501(c)(3) nonprofit organization, which subsequently owns those assets and handles all the administrative tasks and the grant administration process. Some DAFs allow the financial advisor of your choice to manage the investments in your DAF so make sure you know all of the requirements as DAFs vary. Although you recommend where the money is donated to, the sponsor has the final say-so as to where the money goes. While you may get a tax deduction at the time of the original donation to the DAF, you cannot deduct the amount again when the money is distributed from the fund to the qualified charity.

National Philanthropic Trust reported that grantmaking from DAFs to qualified charities increased 93% between 2015 and 2019. With DAFs, no mandatory amount has to come out of the fund. Their popularity has grown in recent years, making them the fastest-growing philanthropic vehicle, due to their flexibility and ease of use.

If you were never one for the limelight or the credit, another benefit of the DAF is that you can make anonymous charitable gifts.

Some restrictions with DAFs, according to the National Philanthropic Trust, include that donors can’t:

  • Advise grants be made to individuals.
  • Receive goods in exchange for donation.
  • Advise grants be used for tuition.

DAFs are a good tool to use when you want to leave a legacy or pass on your values while also giving more meaning to the wealth you’ve built. DAFs are good if you’re passionate about helping others and donating to charitable causes.

If you’re having a hard time picturing it, DAFs can be likened to a checking account that holds the monies that can be distributed later on to various charitable organizations. You can even have your loved ones take over being the successor manager of some DAFs upon your passing.

Cracking the CRT

A charitable remainder trust is an irrevocable trust established to provide annual payments to current beneficiaries – which can be you – with the remainder balance distributed to a charity.

CRTs are a little bit different from DAFs, as they are a trust, customized to your situation and more of an estate planning tool. Essentially, you have your attorney create a trust, you determine what asset you’re going to put into it and your professionals will run the numbers to determine the current and remainder payout parameters.

The lifetime beneficiary payout has to be at least 5% of the trust assets, but cannot exceed 50%. The chosen charity must receive at least 10% of actuarial value of the assets initially transferred to the CRT at the end of its term.

Keep in mind that if the assets you donate are not cash or publicly traded securities, they may need to be appraised. The type of appraisal you get depends on the type of asset it is. For example, if you are contributing art to your CRT, you will need an art appraiser. Your financial professional can help you figure out which type of appraisal to get.

There are two types of CRTs:

  • Charitable Remainder Unitrust (CRUT): distributes a fixed amount each year, but no additional contributions can be made.
  • Charitable Remainder Annuity Trust (CRAT): distributes a fixed percentage on the balance of trust assets, but additional contributions can be made.

Your professionals can help you figure out which type of CRT is the best fit for your situation. Regardless of what type of CRT you use, note that there are fees associated with setting up the trust, including legal fees.

With the CRT, there is a mandatory amount or percentage of the trust assets that has to come out annually to the beneficiary or beneficiaries, as noted above, and there are expenses associated with the administration of the CRT. Those expenses could include paying the trustee to administer the trust and the cost of the filing of a tax return for the trust.

CRTs have a definite endpoint. Payments can stretch anywhere from 20 years to life, but at some point they stop. And also unlike DAFs, gifts from CRTs are not given anonymously. CRTs are great if you have highly appreciated assets and you want to have a defined stream of cash flow for you or your beneficiaries. 

The good news is that both CRTs and DAFs offer tax benefits to you in the form of income tax deductions and capital gains tax deferral or avoidance. Both allow for an immediate tax deduction but the amount of the deduction depends on your specific tax situation, and also what type and how long you have owned the asset or assets that you are contributing. In the case of the CRT you receive an immediate tax deduction on the present value of the assets that will eventually go to charity, several charities or your DAF. Also, in most cases, capital gains tax on appreciated assets can be completely avoided or deferred when assets are transferred into the CRT or DAF and then sold.

CRTs and DAFs can be used together. This happens if you want to set up a DAF as the charity to receive the assets at the end of the term of the CRT.

Working with a Professional is Key

The main reason people give to charity is because they want to help a cause, which is also among the reasons people employ these tools. But there are also benefits to using these tools, nuances you should be aware of and pitfalls to avoid.

Your financial advisor can help you determine the right solution and also run point with your other professionals, like your CPA or attorney, to craft the ideal solution for your unique situation.

This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.

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