WCI versus PoF: A Pro / Con on Donor Advised Funds
Welcome to our first Pro / Con post, a collaboration between The White Coat Investor and me. This is going to be fun.
The White Coat Investor a.k.a Dr. Jim Dahle and I have a lot in common. We are both physicians in a shift-work specialty. We’re the same age. We can consider ourselves to be financially independent in our early forties. We work less than full time and have kids in grade school. We’re both pretty tall thanks to our Scandinavian heritage. Even our names are similar.
Another trait WCI and I share is our proclivity towards charitable giving. Where we differ is how that’s best accomplished. As of today, I have exactly four years of experience with donor advised funds (DAF) and I think it’s hands down the best way to give back monetarily, but I have yet to convince him to open a DAF of his own.
We’ll open with his argument against the concept, and I’ll follow up with my counterarguments and a few additional pro arguments to seal my case. My goal is to be objective and let you, the reader, decide why you agree with me.
The timing of this post is not accidental. There is still time to open and fund a DAF in 2019 to take a deduction at your current marginal tax rate, particularly if you use funds from the same brokerage to fund the account. For example, Vanguard to Vanguard Charitable, Fidelity to Fidelity Charitable, or Schwab to Schwab Charitable.
WCI versus PoF: A Pro / Con on Donor Advised Funds
Physician on Fire and I had a spat on the WCI Forum the other day. He’s a major proponent of a Donor Advised Fund (DAF). In fact, I think the whole blogosphere has been aflame with excitement about this niche account the last few months. Apparently, all of these bloggers use them and have written about them:
- Wealthy Doc
- JL Collins
- Our Next Life
- Investing to Thrive
- Stop Ironing Shirts
- Fetching Financial Freedom
- ESI Money
- Leigh’s Financial Journey
- Doctor Money Matters
- Retire to Roots (blog inactive)
- Plan Invest Escape
- PT Money
- Retirement Manifesto
- Rogue Dad MD
- A Good Life MD
- Chief Mom Officer
- B.C. Krygowski
- TJ Pridonoff (blog inactive)
- The White Coat Investor
- The Best Chapter
- Crispy Doc
In case you’re not aware of how a DAF works, let me briefly explain. You open an account at Vanguard (or wherever) and make a contribution. If you itemize, that contribution can be a tax deduction on this year’s taxes. Then the money stays in the DAF, invested in whatever you like for as long as you like. You pay the custodian a fee each year (the fee at Vanguard is 0.6%.) And then you “advise” the fund manager to donate money to your favored charities whenever you feel like doing so.
Donating to a DAF is a Jerk Move
I think I may be the lone dissenting voice on these. I don’t think they are awesome. In fact, I’ve even called donating to a DAF a “jerk move.” Here’s why:
When you donate to a DAF, you get a tax deduction. But no charity gets any money. In fact, that money might not go to an actual charity doing actual good for decades! The only people that benefit any time soon from you putting money into a DAF are you and the DAF custodian. In fact, sometimes the DAF custodian benefits a lot! Vanguard’s fee is relatively low, but there are plenty out there charging 1% a year or even 1.5%.
Physician On FIRE will surely argue that the DAF fee is no big deal, since the tax drag on that money in a taxable account will be similar. But that’s really quite a straw man.
First, you can tax loss harvest in that taxable account, but you can’t do that in a DAF. In fact, the charity gets REALLY hosed if the value of your asset drops dramatically between contribution and donation. You got a huge deduction, and the charity gets some piddly donation. That’s a real jerk move there.
But the main reason it’s a straw man argument is he is comparing putting money you’re going to donate to charity later into a DAF versus putting that money into a taxable account. I would argue that the comparison should be putting the money into a DAF versus giving money to charity RIGHT NOW. There’s no advisory fee or expense ratio or tax drag on money you give away. It’s totally free. In fact, it works just as well to flush out low-basis shares from your taxable account if you have charitable intentions.
Now don’t get me wrong. Donating to charity is a good thing, no matter how you do it. But if I had to rank the “how” by which one is more impressive to me, I’d rank them like this, from least impressive to most impressive.
- Leaving money to charity when you die. Yes, it’s nice, but you’re really giving your heirs’ money to charity, since you certainly didn’t need it.
- Putting money in a DAF. The sooner you donate it, the more impressive it is to me. Leave it there for decades or even until death? That’s pretty much the same as # 1.
- Giving the money to charity right now. The charity gets the cash right now and can start doing good right now with it. That’s most impressive to me.
In reality, there are really only six reasons to use a DAF and they’re all pretty darn niche. The vast majority of charitable givers don’t need to use one.
Six (Mostly Lame) Reasons to Donate to a Donor Advised Fund
# 1: Indecision
If you just can’t decide what charity you want to support, but want to get the tax deduction for the contribution this year and give to charity eventually, then it’s probably reasonable to use a DAF. But most of us know what charities we like. Put the work in to research your charities and do it right, and right now.
# 2: Selfish Giving
If you’re giving to “feel good” rather than to help others, then happiness studies suggest that giving small amounts at frequent intervals are best. In fact, using a DAF can help you feel good twice-once when you put it in the DAF and once when you take it out of the DAF!
But it seems a little superficial to me. If you have a large sum of money that you don’t need and you want to give to charity, just give it to charity. Spreading it out over decades doesn’t help the charity. It only helps you.
That’s selfish. I mean, not as selfish as giving nothing at all, but it’s not the same as a straight donation. But if a DAF gets you to give to charity for any reason, and you wouldn’t do so otherwise, then sure, use the DAF.
# 3: Screw Up the Charity
If your donation is so huge that it is going to really mess up the charity’s future planning, I suppose using a DAF to spread donations out could make sense. But I can only think of a single charity I’ve donated to over the years that even a $100K lump sum would mess up their planning.
# 4: Get the Little Things Deductions While Bunching
During the year you get nickel and dimed for little $20 and $50 donations here and there. You could use a DAF to do these while still being able to bunch your charitable donations and take the standard deduction every other year.
This option becomes more attractive with the new higher standard deduction and the decreased ability to deduct state and property taxes. But realize this isn’t even possible with most DAFs. The Vanguard minimum donation is $500. You can’t use this thing for the $20 donations.
# 5: You Think a Future Donation Does More Good But Want the Deduction Now
Another argument for a DAF is a bit weak, but I’ve heard Warren Buffett make it before so I’ll include it. Basically, the idea is that the charity can use the deduction more later than they can use it now. Or that you’re such an awesome investor that the charity is better off getting the larger amount after you’ve invested their money for them for a few decades. Like I said, kind of weak if you’re not Buffett, but if you believe it then fine, use a DAF.
# 6: The Charity Can’t Handle a Donation in Kind
Some charities are too small to have a brokerage account and can’t handle you transferring them appreciated shares of stock or mutual funds. These tend to be VERY small charities, but if they’re your favored charity, this could be a reasonable use of a DAF.
For the rest of us, charitable people that aren’t in one of these niche categories above, just give the money to charity directly and skip the DAF. Or at least don’t give yourself a pat on the back for making a DAF contribution until you’ve actually donated the money to a charity. However, realize that you can flush appreciated shares out of your account just fine donating directly to most charities. You don’t need a DAF for that.
The Rebuttal from Physician on FIRE
Since we’re talking about charity today, I can’t help but say this feels like a charity softball game. Not a fastpitch game, but definitely a slowpitch game, and I’ve just been tossed a meatball in the center of the strike zone.
Donating to a DAF is Not a Jerk Move
When you donate money (preferably in the form of appreciated equities with a low cost basis, but cash is also accepted) to a DAF, it’s a one-way transaction. There is no taking it back. It is destined for charity, and so are over 99% of the investment returns over the life of the fund, assuming you choose a low-fee DAF.
Our donor advised funds now hold over $250,000, and I plan to treat the sum much like I do my own nest egg. If I were to stop contributing right now, I could give the equivalent of $10,000 a year in today’s dollars (using a 4% safe withdrawal rate) with a good chance (FIREcalc says >80%) of never running out of money to give in my lifetime.
Yes, our chosen charities would rather have $250,000 now, but if we were to grant $10,000 to $50,000 each to a handful of charities, I’ll bet they’d expect great things from us in the future, and I can’t afford to be that charitable year after year. Does that make me a jerk? I don’t think so.
What is more likely is that we’ll continue to grow the fund — I donate half of my profit from this site to charity via our DAFs, and we’ll probably choose to give more than 4% per year. But we’re already in a position to donate a five-figure sum annually in perpetuity.
Well Known Benefits of Donor Advised Funds
I’ve written extensively about DAFs, and I won’t repeat everything that’s been said, but I think it’s important to highlight some of the benefits that are more widely known.
Donating to a Donor Advised Fund results in an immediate tax deduction.
Just prior to retirement is another time to consider a large lump sum donation. You might drop from the 39.6% (soon to be 37%) tax bracket to the 15% (soon to be 12%) tax bracket.
Capital gains disappear when you donate appreciated securities.
If you have a mutual fund from ten years ago that has tripled in value, you might pay hefty capital gains on the sale to access that money. When you donate the fund, neither you nor the recipient pay the capital gains tax.
While it’s true that some charities can accept funds directly, many can’t and the hassle factor cannot be ignored. A donor advised fund makes it very easy to transfer mutual funds and other assets into the account and donate to charities large and small whether or not they can accept stocks and mutual funds.
You can fund a DAF now, and donate later.
The White Coat Investor sees this as a negative, but I see it as a positive. In his excellent post In Praise of Giving, he talks about how giving takes work. Effective giving does take some effort in researching what types of organizations you want to support, and which specific recipients will best achieve those goals.
When I retire, I won’t have the income to support generous giving. Thankfully, I’ve got the DAF to support decades of giving.
While most of our current giving has been local, effective altruism suggests our dollars would do more good providing clean water to those who don’t have it or medications and vaccinations to third world countries. Our giving may shift more to organizations working on worldwide health issues. Perhaps we are indecisive, and the truth is I haven’t taken the time to research how to best allocate our donated dollars.
There are several highly-rated books shown above on the subject of optimal giving, and I’m a big fan of optimizing. In retirement, I’ll have more time to give and more time to read. Thanks to the DAF, I’ll also have plenty of money to give.
Lesser Known Benefits of Donor Advised Funds
Charitable giving is far simpler with a donor advised fund.
Before I had a donor advised fund, in order to get the benefit of the tax deduction (which allows me to put more money in the charity’s coffers per dollar I part with), I would write a check, enter that donation into a spreadsheet, and wait for a receipt that I would save in a folder to support the itemized deduction.
Now, with one large contribution to the DAF each of the last four years, I may never have to keep track of another donation for the rest of my life. When I log in to my DAF, I can donate to twenty different charities with a few quick clicks and keyboard entries. My year-end giving literally takes less than ten minutes, and there’s no need to track any of it for tax purposes since the deduction has already been taken.
A DAF eliminates the need to bunch deductions.
Alternatively, you could say a contribution to a DAF is an effective bunching of deductions.
The White Coat Investor gave two years’ worth of his normal charitable contributions in 2017 and didn’t give enough in 2018 to itemize deductions, taking the standard deduction instead.
That means any smaller donations he made throughout the year in 2018 will not benefit from a tax deduction. In other words, when Dr. Dahle gives up $100 for a school fundraiser, the school receives exactly $100. If he were giving in a tax-advantated way like a DAF, he could have given closer to $180 at a cost to him of $100.
While it’s true that Vanguard Charitable has a $500 minimum grant, both Fidelity Charitable and Schwab Charitable allow you to grant as little as $50 at a time.
Funding a DAF now makes a ton of sense if you plan to take the standard deduction in the future.
Both Dr. Dahle and I live mortgage free, and we’ll only be able to deduct up to $10,000 in state and local income tax or property tax.
That leaves a $14,400 gap to reach the $24,400 standard deduction for married couples filing jointly in 2019. If we were to itemize deductions every year, assuming we have no miscellaneous deductions like gambling losses or medical expenses or loss to theft in excess of 10% of our adjusted gross income, the first $14,400 of our donated dollars would not qualify for a tax deduction.
Someone in our situations donating $15,000 a year would only be rewarded with a tax deduction on the final $600 donated, reducing tax burden by less than $300 each year.
A better move would be to contribute $75,000 to a DAF in 2019, taking a deduction of over $60,000, and donating the money over the next five years from the DAF. With decent returns, they might be able to give $15,000 a year for six or seven years.
By doing so, instead of saving maybe $1,200 in taxes over five years, the lump sum contribution would result in about a $24,000 reduction in federal and state income tax owed on the 2019 tax return (assuming a 40% marginal tax rate between federal and state).
Anonymous giving is a cinch with a donor advised fund.
With each grant from a DAF, you decide how much information is shared with the recipient. You have the option to share full details including name and address, limited info such as the name you assigned to your fund only, or no information at all.
Anonymous giving is an excellent way to stay off the mailing lists of the charities you support, and could actually save the charity the money they would spend on sending you marketing materials.
The psychological benefit of pre-paid donations.
I don’t love parting with money. My relative frugality is a trait that helped me become wealthy, but it can also lead to some miserly Scrooge-like behavior.
By donating to a donor advised fund, I’ve funded many years worth of donations. I don’t have to convince myself each year that we can afford to give. I’ve already made that determination and parted with the money.
Now, when I donate, it’s like I’m playing with house money. Donations from my DAF don’t affect my net worth or personal financial future. As Dr. Dahle pointed out, I get to pat myself on the back twice. But only one of those back-pats costs me any money.
While it’s true that many of the benefits of giving to a donor advised fund can also be realized by direct charitable giving, there are some unique benefits to using a DAF.
- “Donation smoothing” or the ability to give every year with no concern about exceeding the standard deduction.
- Simplified giving. In 2017, we made 28 grants to 25 recipients. The DAF keeps track of those recipients and I can give to them again by checking the box next to it’s name and adding a dollar amount. It’s much easier, faster, and none of it needs to be reported on Schedule A of your 1040. In 2018, we donated to well over 100 charities, with 100 of those grants arising from a single blog post.
- Anonymous giving. While this can be accomplished outside of a donor advised fund, within the DAF, it literally requires one mouse click.
- Psychological benefits. People with DAFs give more generously than others.
- Tax arbitrage. A DAF allows you to donate at your current marginal tax bracket, which could drop in the future. Mine dropped when I started working part-time. It will drop again with the Tax Cuts and Jobs Act (from 33% to 24%) and will drop again when I retire and no longer have an income. But every donated dollar will have benefitted from a healthy tax deduction in a high marginal tax bracket.
That last point deserves a little more attention. It can be seen as greedy, but that’s not at all how I view it.
When you get the most bang for your buck by taking a larger deduction, the ultimate benefit goes to the charities you choose. If you decide you’d like to give $1,000 of your money and you’re in the 12% tax bracket, you can donate $1,136 at a cost of $1,000 to you after the $136 you get back on your taxes.
If you decide you’d like to give $1,000 of your money and you’re in the 39.6% tax bracket, you can donate $1,655 at a cost of $1,000 to you after the $655 you get back on your taxes.
These examples assume you have itemized deductions that exceed the standard deduction, which is nearly doubling in 2018. If you don’t have enough deductions to itemize, some or all of your donated dollars will only result in an equal value to charity.
Why would you not attempt to maximize the “government match” with every dollar you choose to give?
As I said above, there is still time to start a Donor Advised Fund in 2019.
For more information on Donor Advised Funds, please see all of my posts on the topic:
What do you think? Is donating to a DAF a “jerk move”? Does a donor advised fund make sense for you? Have you opened one recently, or have plans to do so in the next five days?