Are Donor-Advised Funds Useful?

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My friend David Anderson, a retired banker now living mainly in New Hampshire, is very interested in charitable giving and wants to know more about an increasingly popular tool known as a donor-advised fund.

“What are the chances of legislative changes that might affect charitable giving and donor-advised funds?” Mr. Anderson asks. “How do these donor-advised funds work, and are they a good way to give to charity?”

These are timely questions as millions of taxpayers consider the intricacies of year-end tax-saving maneuvers, including charitable-giving strategies.

More than 36 million federal income-tax returns for 2013 reported deductions for charitable contributions, according to the Internal Revenue Service. And donor-advised funds are “a quickly growing part of the charitable sector,” says a report by Ellen Steele and C. Eugene Steuerle for the Urban Institute’s Tax Policy and Charities Initiative.

Many thumbs up

Let’s start with Mr. Anderson’s questions about how these funds work and whether they’re a good way to make charitable contributions.

Donor-advised funds have surged in popularity over the years, and many tax lawyers, accountants and financial planners enthusiastically recommend them as a tax-efficient, highly convenient and remarkably simple charitable-giving vehicle.

With a typical fund, you can make your donation in the current year and take a tax deduction for that year even if you don’t decide which charities should get the money until future years. Meanwhile, the money gets invested and can grow, tax-free.

“They can be a very useful vehicle for many people who want to make a gift in one year and distribute it later,” says Carol G. Kroch, managing director, wealth and philanthropic planning, at Wilmington Trust in Wilmington, Del.

Why would you want to do that? There are several possible reasons. For example, you might conclude this is an ideal year, for tax purposes, to make large amounts of charitable donations but you haven’t selected which of your favorite charities should get some, or all, of those gifts. Or perhaps you are concerned that lawmakers might impose new curbs on charitable-giving deductions for upper-income taxpayers in future years, and thus it would be best to take as big a deduction as possible while you’re sure you still can.

At a recent tax seminar at Baruch College in New York, Sidney Kess, a veteran tax expert and author, asked the audience for their reactions to donor-advised funds. Many hands shot up, and several certified public accountants gave the funds rave reviews. “They are an excellent way for many people to donate to charity,” Mr. Kess said in an interview.

Do your homework

You can sign up for a donor-advised fund through many institutions, including such investment giants as Fidelity Investments, Charles Schwab, T. Rowe Price Group and Vanguard Group. But before you pick one, do some homework.

Details can vary widely from fund to fund on many terms and features, such as the minimum initial contribution, the minimum-size grant, fees and investment options.

ENLARGE

You don’t need to be super rich to set up an account. At Fidelity Charitable, for example, the minimum initial contribution is $5,000. That’s also the minimum at Schwab Charitable. Others have significantly higher minimums.

For the grants you make, the minimums are much lower. The minimum grant at both Fidelity and Schwab, for instance, is $50.

At Fidelity Charitable, the median account size is about $16,000, says Amy Danforth, the fund’s president. In 2014, Fidelity Charitable made $2.6 billion in donor-recommended grants to more than 90,000 charities. That’s more than double the $1.2 billion granted in 2010. (Personal disclosure: My wife and I have long held an account at Fidelity Charitable and make many of our donations—but not all—through it.)

Doings in Washington

As for the legislative outlook, President Barack Obama has called for new limits on the value of itemized deductions, including charitable donations, for high-income taxpayers. And last year, then-Rep. Dave Camp, a Michigan Republican who at the time was chairman of the House Ways and Means Committee, proposed a major tax-law overhaul that included important changes involving charitable-gift deductions. He also proposed requiring that assets parked in donor-advised funds (sometimes known as charitable-gift funds) be distributed within five years of when they were placed there.

These proposals all have something in common: They have little or no chance of becoming law anytime soon.

“This is not a Congress that has been active on tax legislation,” says Ms. Kroch of Wilmington Trust. “They have an awful lot on their plate by year-end. I don’t see this high up on their priorities.”

But there is an excellent chance that Congress will take action in another arena that involves charitable giving. Lawmakers probably will vote in coming months to extend the life of a popular tax break that expired at the end of 2014.

The provision allowed taxpayers who were 70½ or older to donate as much as $100,000 directly from an individual retirement account to qualified charities without having to count any of that money as income. If done correctly, that direct transfer counted toward the taxpayer’s required minimum IRA distribution for the year.

Caution: Under the law that expired at the end of last year, donor-advised funds and supporting organizations weren’t eligible recipients for this provision. Nobody knows whether—or when—Congress will act on this and many other expired provisions, and whether lawmakers might tweak the rules for 2015.

Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send your comments and tax questions to taxquestions@wsj.com. Please include your full name, address and phone number in case we need to contact you to get more details about your question.