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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

The Basics of Donor-Advised Funds: Tax Benefits and Flexible Charitable Giving Strategies

In this episode of Friends Talk Financial Planning, John and Bridget dive into the basics of Donor-Advised Funds. They discuss how these funds allow individuals to maximize tax deductions while retaining control over their donations. They explain the concept of a donor-advised fund, its benefits, and when it might be advantageous for someone to use.

Additionally, they touch on the implications for individuals who do not itemize their taxes and the potential strategies for controlling the timing of tax deductions. The episode also delves into the advantages of donating appreciated stock to a donor-advised fund and the streamlined process it offers for charitable donations. Furthermore, the hosts explore advanced strategies related to donor-advised funds, hinting at future episodes to come.

Whether you're new to financial planning or seeking to enhance your knowledge, this episode provides valuable insights into the world of donor-advised funds. Subscribe for more helpful tips on financial planning, and stay tuned for future episodes where John and Bridget will share additional strategies and experiences related to donor-advised funds.

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John: If you could make donations where you maximize your tax deduction but still keep control over that money. Sound too good to be true? That's what we're going to talk about on today's episode of Friends Talk Financial Planning. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel. I've got a fee only financial planning practice in Chicago, Illinois. Before we start talking about Donor-Advised Funds, we just want to remind people to subscribe. It helps us with YouTube. Okay, John, let's dig into it. Can you just describe what the heck a Donor-Advised Funds is, and then we'll get more into the topics about why somebody might want one?

John: Yeah, it's funny, in the introduction, we said, “Give money away and keep control. Sounds too good to be true, right?” And usually those things are, but it’s exactly what you mentioned, Bridget. There's a thing called a Donor-Advised Funds that can help accomplish both those things. And so, we'll talk about what it is, how it works, and where somebody might want to use it. When I describe it to clients, I say that it's like a mini foundation, a private foundation.

If you're super rich, like the Rockefellers, you might have a foundation to give money away from your family. It’s a similar process with a Donor-Advised Funds, but without all the red tape and the requirements and all the costs that go along with that. So in real simple terms, it's like a mini foundation. And what it means is that regular people can put money into this account called a Donor-Advised Funds. That account is like a separate charity. You put your own name on these accounts, and you have them at the local community foundation.

We do them at Schwab for our clients. I'm sure you do, too. Fidelity, Vanguard, they've got these as well. So we set up an account. My wife and I have one. It's called the Scherer Family Charitable Fund or something like that. We donate money into that fund. It's like our little mini foundation. We get the tax deduction when we put money into the Scherer Charitable Fund, our Donor-Advised Funds, that's when we get the tax deduction. Then the money sits in there and it'll grow; it gets invested.

And we make donations to charity, then, from this Donor-Advised Funds; we give money to United Way and to the church and to cancer society and those things from the Donor-Advised Funds. So big picture, it's like a mini foundation. It’s very low cost, very low administrative hassles, easy to use, and it's a place where regular people can give money away, not unlike the Rockefellers and the rich folks do.

Bridget: So there's one thing I want to bring up with this and that is itemizing. If you don't itemize for your taxes, meaning you're not able to take a charitable contribution anyway, is a Donor-Advised Funds for you?

John: That's a great question. So here's my answer to that. I'll be interested to hear your answer to it. If the tax deduction isn't an issue, then that doesn't make any difference, necessarily. If I'm giving $1,000 a year or $2,000 a year to charity and I'm not getting a tax deduction for it, the Donor-Advised Funds, all the things we'll talk about why it can work in this foundation still apply. There is one area where, listen, we might want to give more money to the Donor-Advised Funds in a given year. We'll talk about that. We can get into some details. Maybe that's a whole separate episode on some of the nuances of things, but there might be reasons why we might give a couple, three years of charitable donations in one year to take that tax deduction.

And I guess for me, that sort of lends into saying, “So it's this mini foundation. That's great. Why would I use it?” And the one big place that we see where clients take advantage of this Donor-Advised Funds is to control the timing of the tax deduction. And what I mean by that is when we've got a particularly high year of income, and I know that next year or some point down the road, we're going to have a low tax year we might use the Donor-Advised Funds. We've got a client that sold a building that had a lot of capital gains in it, so their tax bracket goes way up just for this year.

Next year, the year forward, we know that their tax bracket is going to be much lower because this is a big investment that they sold. We can take the tax deduction this year. If we’re giving $2,000 a year to our church or to the United Way or to charity, we go, “Jeez, we're going to do that every year for the next ten years. Why don't we take that $20,000 of donations and take the tax deduction today at 35% or 40% or whatever it is, because that donation in five years is only going to save 10% or 20% in taxes.” So controlling the timing of the donation in those high years.

Bridget: So I want to mention that one element about control is that while you do control the timing of your tax deduction, you then have to give the money to charity.

John: Right.

Bridget: So you can’t take the money back. It's not yours anymore. It's in this charitable fund. And so, you can't say, “Oh, I need the money, I'm taking it back.” So you do lose control from that perspective.

John: Yeah, it's a great tool, but it's only money that you are already going to donate to charity. It's not like saying, “Oh, jeez, it's free money.” You control where it goes ultimately to which charity and at what point in time it goes there, but you are giving this money away. I'm glad you brought that up. I don't own this money anymore. I still control where it goes, what charity it goes to, but I don't own that anymore. And in my case, the Scherer Charitable Fund is the charity, so that when that fund doles the money out to the different places, that's not a tax-deductible event, because it's from charity to charity.

Bridget: Right. So I wanted to talk about where I see it the most in my practice. And that is when people get paid through stock at their company. So people get restricted stock units or for whatever reason they're getting paid through stock, or they buy stock through an employee purchase plan. And this is especially true if that stock has gone up. So Chicago has the good fortune of having some companies that have done really well over the years. So if that stock has gone up, then there's a big gap between how much they paid for it and what it's worth now.

And if they were to sell the stock, they're going to pay all of capital gains on that. But if they donate the stock to their Donor-Advised Funds, they get the tax deduction at the fair market value and they don't have gains on it. It's a great planning tool for us. That's one of the things that we do every year with clients, asking, “Okay, how much are we putting in this year?” And again, we ask this question in conjunction with what's your tax bracket looking like and what do we think your tax bracket is going to be in the future?

John: Yeah, I love that. And I don't see as many people who have the company stock that’s going up, but just in general if I put $1,000 into Apple or whatever the stock is, and that sucker has soared, and now it's worth $10,000, Donor-Advised Funds are perfect. And I think you had a blurb or a graphic from a charitable fund. Maybe we can pull that up and put it in the notes so people can see that. I could sell that stock, pay the capital gains taxes, and give it to charity. Or I could just give the stock to charity.

 I don't pay any taxes, the charity gets the full deduction, and we're basically cutting Uncle Sam out of the picture on things. That's the place where I see it fitting really well. We've got timing of the deductions, asking, “When do I want to take the deduction?” But then I've got a stock that's gone up or mutual funds that have gone up or an investment that's gone up, and that’s also a good place to focus. And one of the things we look at on people's tax returns when new clients come in or prospective clients come in, is are they giving money to charity?

Do we see that on schedule A, if they're itemizing, and do they have capital gains, meaning they've got stock that's gone up in some fashion. If we're paying taxes on capital gains and we're giving money to charity, we got to connect those two dots and go, “Does it make sense to do this through giving appreciated stock or mutual funds that have gone up to charity?

Bridget: Exactly. And the thing is that you can give appreciated stock to charity anyway. If you want to give to a charity, you can call them and say, “Hey, do you take appreciated stock?” They don't even have to be a large charity.

John: Almost any charity will accept it.

Bridget: Yeah, they'll take it, and you can get a deduction of a 501(c)(3). However, I've had clients that have actually done that, and it's usually not at Schwab but some old mutual fund company they had, and it just takes work. And with the Donor-Advised Funds, once you set it up, it makes it really streamlined. And we can help clients with it, too. So that's one of the things I like about Donor-Advised Funds; it makes it very streamlined to donate appreciated stock to charity.

John: Yeah. And I love that idea. And I'm glad you brought this up. Listen, if you're going to give a few thousand dollars to charity, you don't need to do it through a Donor-Advised Funds. Still give the appreciated stock. Give that to the church, United Way or whatever. But here's the situation we have quite a bit. A lot of our clients don't give $1,000 or $5,000 to one charity in a year. It's $250 here and $500 there and $100 there. And there might be 20 different charities. And so, listen, if I want to give some of my investments that have gone up to charity, I can do that, but do I want to do it at 15 different times or do I want to do it once to my Donor-Advised Funds and then write a check from the Donor-Advised Funds.

We use Schwab, and it's really simple. You go on, in a couple of clicks, you are able to send the money to the charities. And it reminds me about what charities I gave to last year. I often think to myself, “Oh, that's right. I haven't given to this charity in a couple of years. I need to support them again.” The history is there; it's really slick. I did want to bring up, before we wrap up, what are the downsides? Why wouldn't you use a Donor-Advised Funds? And in my experience, the downsides are very limited. There're not a lot of downsides, but there is one that has come up that I want viewers to be aware of.

You might have a company matching plan. And you mentioned some of the larger companies down in your area, and we've got some around here where, listen, if I give money to charity, maybe my company will match up to $100, $500, $1,000, and that's a great way to double my giving. We've had some instances where we've had clients that had that company matching for charity, but when the money went from the client into their Donor-Advised Fund, the company said, “Well, that's not really the end charity, so we don't match that.”

And then when it went from the Donor-Advised Fund to United Way or whatever the charity, it wasn't a taxable donation, and so the company didn't quite know how to match those donations. So that's the one place where we've seen downsides. Other than that, we haven't had any glitches. The only thing we’ve seen is if your company matches, you might want to check with them before you fund a Donor-Advised Fund, just to make sure you're getting your goals accomplished with things.

Bridget: Yeah. And the other thing I want to say is that we're going to do another episode on this as well, and we're going to talk about some more advanced strategies like bunching and involving your kids, so tune into our next episode or our upcoming episode for even more experience and strategies about Donor-Advised Funds.  

Bridget: So with that, I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients, so if you're interested, we'd love to hear from you. But we're also both members of the Alliance of Comprehensive Planners, and if you like what you hear on our show and want to talk with a planner who thinks like us in your area, you can check out

Bridget: And don't forget to subscribe.


At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.


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