Getting involved in philanthropy is not only a great way to give back to the causes you care about most, but it can also provide an excellent opportunity to optimize your tax strategy.
When it comes to choosing how you make your charitable contributions, two of the most popular charitable giving vehicles to choose from are a donor-advised fund DAF vs. private foundation. Both forms of giving provide tax deductions, flexibility to recommend grants, allow you to leave a legacy for the next generation, and offer tax-free growth of any investments you wish to use for charitable purposes. That said, there are several key differences between the two and the right giving vehicle will depend on your unique needs.
In this article, Avidian Wealth Solutions, a boutique family office that offers services similar to that of an ultra-high-net-worth family office including advising clients on charitable giving strategies, is here to walk you through the biggest differences between a DAF and a private family foundation.
What is a donor-advised fund (DAF)?
A donor-advised fund (DAF) is a charitable investment account, typically managed by a third party or sponsor organization, that allows you to deposit assets for donation. These assets are invested into the market for tax-free growth until the fund owner recommends how and where they want to donate their assets.
What is the benefit of a DAF? Outside of the obvious philanthropic benefits that come with donating to important causes, one major benefit of a DAF is the reduction in your tax liability. When you make a charitable contribution to your fund, you are able to take an immediate tax deduction which can offset some of the gains you might have made through selling a business or high-performing security.
What is a private foundation?
A private foundation (PF) is a separate legal entity (legally classified as a 501(c)(3) organization) that is formed for the purpose of recommending philanthropic grants. Private foundations can be non-profit organizations and are owned and funded by an individual, family, or corporation. Unlike a public charity or non-profit, private foundations are typically funded by their own investments rather than by donations.
One of the main benefits of a private foundation, outside of expanding giving opportunities for those who wish to make a difference, is that they offer tax savings while allowing families to create a lasting legacy they can pass down in a way that offers the most control over where and how their charitable dollars are being used.
What are the differences between a DAF vs. private foundation?
Donor-advised fund (DAF)
Donor-advised funds offer complete privacy, allowing you to donate to whichever causes matter most to you without fear of public backlash.
As a legal entity, private foundations are required to file their own tax returns at the end of the year. Because Form 990 is a publicly searchable record, private foundations are a less secure option when compared to a donor-advised fund. In other words, anyone can look up information about your private foundation including asset values, who is on the board of trustees, and the charities to which you have donated.
Required distributions and investments
Donor-advised fund (DAF)
As of right now, there are no minimum distributions for DAFs, and investment options are up to the sponsoring organization. Depending on who you partner with, you may be required to use the investments offered on their platforms or you could have the freedom to use your own investment advisor to manage your assets.
The board of trustees or directors of a private foundation are in complete control over the investments held in that private foundation. Outside of specific laws against where a private foundation can donate, PFs can invest their assets wherever they want so long as they donate at least 5% of their assets annually.
Donor-advised fund (DAF)
Donor-advised funds are simple to set up and manage seeing as how you partner with a sponsoring organization for its management. Depending on your account size and the assets under management (AUM), you’ll likely pay a management fee. You may also opt to have your current investment advisor handle your portfolio allocation allowing you to be completely hands-off until you are ready to make a donation.
Private foundations require a large initial investment and can be costly to maintain. Depending on the size of your private foundation, you may need to hire dedicated staffing that will need to be overseen. You are also responsible for recordkeeping, creating a giving strategy, reviewing grant requests, recommending grants, and evaluating the effectiveness of your donations.
While you still have the freedom to donate and recommend grants to any IRS-qualified public charity you want, your charitable donations will be administered by the managing party.
Conversely to donor-advised funds, private foundations offer families complete flexibility over where and how they can use their charitable equity. This includes investing in private real estate or other means of private equity.
You are able to donate complex assets to your donor-advised fund including businesses, real estate, oil and gas, collections, cryptocurrency, private equity, artwork, intellectual property, and stocks.
Similarly, charitable contributions to a private foundation can include everything from cash, life insurance, and stocks to private equity and real estate.
A DAF can be passed on to future generations by naming them as your successors. Or, you can name what charities or organizations you’d like the funds to go to after you’re gone similar to how you would donate your IRA to charity at death. If you do not specify what you want to happen to the funds in your DAF, they will become part of the sponsor organization’s endowment.
Charitable giving is one of the many elements of estate planning. One major incentive for many private family foundations is the ability to leave a legacy behind for children and grandchildren. You can also name your private foundation as the beneficiary of your IRA, avoiding any income tax and enabling your family access to tax deductions for your estate.
Donating appreciated assets to a donor-advised fund can be a valuable part of your tax planning in Houston. As per tax laws, deduction limits for public charities like donor-advised funds are 60% of your adjusted gross income (AGI) for cash donations or 30% for assets and deductions can be rolled over for up to 5 years.
The laws for private foundations are similar to those for donations to public charities but the deduction limits are 30% of your adjusted gross income (AGI) for cash donations and 20% for appreciated assets.
Partner with Avidian Wealth Solutions to establish your effective charitable-giving strategy.
Private foundations offer a flexible giving solution for families with large sums of wealth to dedicate towards their charitable visions. However, depending on your charitable goals, opting for a DAF vs. private foundation can be a simple way to give back to your community, minimize tax losses, and encourage family philanthropy without the complexities or costs associated with managing your own private foundation. The key is finding the right sponsor organization to partner with.
Avidian Wealth Solutions is a Houston-based wealth management firm that offers donor-advised funds to our clients as part of their customized financial plan. When you partner with us, you gain access to the private donor “back office” experience but without the expense of staffing your own private foundation. Our multi-disciplinary team of financial professionals is also able to evaluate the impact of your investing, working to make the most of your charitable dollars.
If you’d like to learn more about how we can help you establish an efficient charitable giving strategy, schedule a consultation with us today!
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