Donor Advised Funds: An Overview
Q4 | November 2021
Topic: Foundations & Endowments
November 2, 2021
Image used with permission: iStock/pixelliebe
Donor Advised Funds: An Overview
Q4 | November 2021
As we approach the end of the calendar year, taxes and charitable giving inevitably surface as ”things to do” in peoples’ minds. Here, we’d like to focus on one specific topic: the donor advised fund (DAF). As is the case with all tax and estate considerations, the appropriateness of creating a DAF will vary based on each client’s circumstances. After reading this blog, if you think that a DAF may have a role in your personal financial plan, please connect with your Nexus contact to discuss further.
What is a DAF?
Unlike a normal donation (where the donation of the money and the designation of which charitable organization will receive the funds occurs simultaneously), using a DAF allows you to make a donation now, but the donation effectively goes into a “holding tank” (the DAF). In the DAF, your donation can be invested, grow tax-free over time, and any part thereof can be granted (designated) to the charitable organizations of your choice later – months, years or even decades later.
Much like a registered private charitable foundation, a DAF is a philanthropic vehicle that allows you to make and manage charitable donations as an individual or a family. Once it has been established, you are able to direct to whom and when designations to charities are made. You can incorporate your philanthropic goals and personal/family values into the way the DAF is invested and how the designations are made. Compared to having a registered private foundation, we like DAFs as they are much easier to create, lower cost to operate, more flexible, and offer full privacy. Notably, a DAF is only suitable in limited cases – we suggest a minimum initial donation of $100,000. While sizeable, this is dramatically smaller than what is required for a private foundation.
Here are some of the advantages of a DAF as we see them. Hopefully, by understanding the advantages, you can assess the appropriateness in your case.
Opportunity to make charitable donations on your own time/schedule
The timing of getting a tax deduction and giving to charity need not be the same. Sometimes there is a reason to make a large donation for tax purposes (such as an event that triggers a major tax bill – frequently the realization of substantial capital gains) and then spread the giving out over multiple years. Alternatively, it may make sense to donate for tax purposes only during your higher earning years but distribute funds to charities at a later date.
Donated funds continue to grow tax free
If large-scale giving is on your radar, donating and then subsequently investing the funds in the DAF can increase the size of your gift. By donating sooner and investing the funds within the DAF, all future investment growth on the donated money is now tax-free, so the DAF will grow more quickly than if you invested the funds in your personal account (which effectively grows at a lower after-tax investment return) and donated it in later years.
A DAF can be a recipient of funds in your will
If you have an established DAF, it can be named as a beneficiary in your will. This can help with “right-sizing” your estate and promotes intergenerational giving if you want to have your family involved in your long-term giving plan.
Continue to have the money invested with Nexus
One important factor when considering a DAF is who will manage the funds (and how much that will cost) once you have made the donation. We work with several DAF administrators who can hold your DAF account at Nexus. This enables us to continue to manage our clients’ DAFs in our pooled funds, along with allowing flexibility in desired asset allocation.
Maintain your Nexus fees on your DAF
Once funds are donated to the DAF, they are no longer yours. Despite this, we will link the DAF account with your Nexus portfolio for fee calculation purposes, so that our fee will remain the same as if the DAF were still within your group of accounts. This results in a lower effective investment management fee compared to having the DAF and your remaining portfolio managed as separate, stand-alone portfolios.
Much easier upfront and long-term, compared to a private foundation
There is no comparison between a DAF and a private foundation when it comes to what’s required, both in terms of work and cost. Running your own foundation requires an independent board (or a trustee), creation of a new legal entity, approval and registration of a charity with the CRA, as well as the ongoing requirements of tax filings, audits and evidence of meetings. DAFs are much simpler and can be opened quickly with minimal paperwork. This is because the DAF administrator and Nexus take care of all the administrative requirements. In addition, all the information that is effectively made public for a private foundation, due to its registered nature, can remain private for a DAF. If you so choose, nobody other than Nexus and the DAF Administrator need even know that you have a DAF. For more information on DAFs vs. foundations, please see this blog by Dianne White.
At Nexus, we have managed investment assets held within DAF accounts for many years. While the management of DAF investment assets is not new to us, we have recently developed a working relationship with additional DAF administrators that we had not previously collaborated with. This means that you have a broader set of choices for the DAF administrator and you can choose the one that best meets your needs. We look forward to sharing this information with you, should you be interested.
What are the total fees associated with a DAF?
The total cost will be composed of the fees charged by the administrator and the fees charged by Nexus. Because the administrators are charities, these fees are expense recovery charges that range from 0.60% for a very large DAF to 1.25% for a smaller DAF, depending on the administrator you work with.
Nexus will charge an investment management fee on your DAF that is based on your existing fee schedule, so there is no change in the total investment management fee paid across your DAF and your remaining portfolio. This is significantly better than the typical requirement of having the investment management fee separately applied to a stand-alone DAF.
What is the minimum donation required to start a DAF?
Nexus requires a minimum investment of $100,000 to open a DAF that will be managed by Nexus. Some DAF administrators have a lower minimum (but typically higher all-in costs).
Can I involve others with donating into the DAF or deciding how to disburse the funds?
Yes, anyone can donate to your DAF, and you can name additional advisors if, for example, you want to involve family members in your DAF or have them eventually replace your role entirely. The charitable tax receipt will always be issued to whoever makes the donation.
What kind of charities can I donate to?
Designations can be made to any Canadian charity registered with the CRA, as well as a number of international educational institutions that the CRA has approved.
Who technically owns my DAF account?
Once a donation is made to a DAF, the funds are no longer yours. They “belong” to the not-for-profit foundation that your DAF is a part of. You can provide input (hence the term donor-advised fund) on how the investments are managed and are the assets are granted, but you cannot take them back.
Is there a minimum annual distribution from a DAF?
The CRA requires that all foundations (and your DAF would be a sub-component of one larger foundation) distribute at least 5% of their total assets annually. In most instances, each individual DAF is required to distribute 5% annually.(1)
Can I change DAF administrators or investment managers once I have opened a DAF, or otherwise close the DAF entirely?
Yes, you can change administrators or investment managers for an existing DAF. Any investment manager must be approved by the DAF administrator. The original form of DAFs had a required minimum life (usually 10 years). You can now open a “flexible” DAF that can be shut down at any time, by simply granting all the funds in the DAF and requesting that it be closed.
(1) The original post of the article stated the annual distribution at 3.5%, however, we have since updated this article to reflect the current 5% distribution as of 2023.