Posted By: CFP&WM On: Dec 15th, 2016 In: Money Matters Comments: 0

How to Make the Most of Your Donor Advised Fund

Donor advised funds (DAF) are one of the fastest growing vehicles for charitable giving for those in the upper middle and affluent classes. There are many reasons for this growth, including:

  • Income tax benefits
  • Ease of ongoing operation
  • Flexibility in changing favorite charities over time
  • Encouragement for younger generations to be charitably minded.

There are three primary tasks associated with a DAF, namely establishing the DAF, making contributions to it and making grants from it. (For more, see: Is This the Best Time to Start a Donor Advised Fund?)

5 Grant Level Options

The purpose of this article is to present some options for determining the amount of the DAF funds that could be granted to your favorite charities each year. Which option is best for you will depend on several factors, including:

  1. Will you be making more donations to the fund in the future or is this a one-time donation? Clearly, if you plan to make additional donations in the future you may feel that you could offer grants in higher amounts because future donations would replenish the fund.
  2. What is the size of your contribution to the DAF? If it is a small amount, say $5,000, then it may not last as long with any meaningful grants as opposed to larger donations of say $100,000 which could grant more significant amounts over a longer period.
  3. Do you care how long the funds in the DAF last? Does it matter whether it’s five, 10 or 20 years? Or are you thinking longer term, say 100 years? If it doesn’t make too much difference how long the DAF continues, you could grant larger amounts each year. However, if you want the DAF to last 100 years the level of grants would likely need to be lower.
  4. Do you want the option to teach the younger generations in the family about the benefits of charitable giving and the family values that the older generation espouses? For some people, this is a primary reason to have the DAF in the first place. Having the DAF last for a number of future generations is critical to those individuals, thus more conservative grant levels would be appropriate.
  5. How aggressive or conservative are the funds in the DAF invested? The more aggressive the investments the higher the average rate of return. Conversely, the more conservative the investments the more stable the account value but the lower the expected return. If you selected a very aggressive investment mix and another 2008 financial disaster occurred, you could see your $100,000 account lose half its value, or more. On the other hand, if you were only invested in bank CDs, given the low rate environment, the return on your $100,000 might only be $1,000 for the entire year. (For more, see: Questions to Ask Before Starting a Donor-Advised Fund.)

Common Methodologies

Below are some common methodologies for determining the level of grants to be made to charities every year:

  1. Set dollar amount. This is the easiest determination. It makes no difference how long the funds in the account will last, how the money is invested or the expected rate of return. Each year, you know exactly how much of the funds you will be granting.
  2. Seat of the pants. Simply put, you have no plan at all. You just pick an amount out of thin air, based on whatever motivates you at the time: “The annual return was low or high so I will make ‘X’ amounts in grants.” “There was a terrible disaster and I want to help so I will grant ‘X’ amount.” “I am busy and didn’t think about it and no grants were made this year.” “My family member died this year and I want to make a big grant in her/his name.”
  3. Income only. This option helps ensure that the DAF lasts a long time. Let’s say that the initial amount is $100,000 and the funds are invested in income-producing assets. At the end of the year, there were $3,250 in dividends and interest. This would be the amount available for grants the next year.
  4. Set percentage of the fund’s value. Each year, you make grants based on a percentage of the account’s value at the end of the prior year. Let’s say you start with $100,000 in the account. If the first year’s return was 6%, you would grant $6,000. If in the following year the markets went up 10%, you would grant $6,600 (6% of $110,000) the next year. If, on the other hand, the markets did terribly and were down 30%, then you would only make grants of $4,200 (6% of $70,000). This works well for those that want the DAF to last for a longer period. It also allows for a bit more aggressive set of investments.
  5. Grant amounts over the donated principle. With the example of $100,000, if the account grows to $110,000 then $10,000 would be available for grants the next year. If the account went down to $90,000, no grants would be made until the account grows back over the $100,000 level. This allows for a more aggressive set of investments but could mean that no grants are made in some years.

If you have established your DAF and have contributed to it, then you should determine what method to use in setting the annual grant amount each year. Have a plan, but be flexible enough to change if needs mandate. (For related reading, see: Cut Your Tax Bill With Donor Advised Funds.)

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