Donor-advised funds and charitable remainder trusts are often viewed as mutually exclusive philanthropic strategies. And while many debate the advantages of each, combining them offers leveraged tax deductions, income back to the donor and, in the end, a legacy gift to charitable organizations on your terms.
So, how does one maintain the flexibility to freely change charitable beneficiaries and enable continued family involvement, yet generate a stream of income during their lifetime? The key is to name a donor-advised fund as the beneficiary of a charitable remainder trust.
The Pros And Cons Of Donor-Advised Funds
As defined by the IRS, a donor-advised fund (DAF) is a “separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.” It allows donors to make a charitable contribution, receive an immediate tax deduction and then recommend grants from the fund over time.
A donor, or donor’s agent, can make ongoing, nonbinding recommendations to the DAF as to how, when and where grants from the fund should be made. Additionally, the donor can offer advice to the DAF regarding how contributions should be invested. However, the fund is not obligated to follow any of the donor’s suggestions—hence the name “donor-advised fund.” As a practical matter though, the DAF will generally follow a donor’s wishes. Nonetheless, a DAF offers an easy way for a donor to make significant charitable gifts over a long period of time and enjoy the tax benefits of giving to charity.
Despite its popularity, one overlooked fact about a donor-advised fund is that once the assets are gifted, they cannot generate income for the donor during his or her lifetime. Clearly, that can give pause to investors who are looking for additional income. The solution may begin with the creation of a charitable remainder trust.
Taking Income Through A Charitable Remainder Trust
The charitable remainder trust allows the donor to make a tax-deductible charitable gift and to take fixed or flexible income over single or joint lives. At death, the remaining balance in the trust is generally disbursed to a charity, but with a donor-advised fund as the beneficiary, the ongoing distribution of gifts can continue. With a charitable remainder trust, the flexibility to change a charity beneficiary is more limited than with a donor-advised fund. The trust itself will have to be updated to reflect changes in charitable beneficiaries. Again, the solution may be to name a donor-advised fund as a beneficiary.
In practice, the donor creates a charitable remainder trust, names the donor-advised fund as the ultimate beneficiary of the trust and receives an income for the term of the trust. When the donor dies, they will have received the benefit of income, while also maintaining the flexibility and convenience of giving through a donor-advised fund.
Please note that it usually requires a donation of substantial assets for this strategy to make sense. The charitable remainder trust is irrevocable, meaning that it likely cannot be changed once it is created, with a few exceptions. Legally, you no longer have control of the assets in the trust.
Leaving A Legacy
Decisions around the selection of charities and the family values on which those charities are chosen can bring generational continuity and cohesion among generations about family wealth. A donor-advised fund allows those decisions to continue within the family even after the death of the original donor. Discussions around philanthropy can bring families together to define values and build a mission statement.
To start creating this philanthropic strategy, bring together a team of advisors with extensive experience in charitable planning and legal, financial and tax expertise.