Donor-Advised Funds Vs. Private Foundations
There is an abundance of ways to give money to charities. However, many serious philanthropists choose one of two methods that can make a significant impact: a private foundation or a donor-advised fund (aka DFA).
Foundations do make up a significant portion of our philanthropic giving in the US. They come in several “flavors” including public, private, corporate, and family foundations.
Individuals or families can use private or family foundations to channel their significant wealth to the causes about which they feel most passionate. Some family foundations are household names, such as the Bill and Melinda Gates Foundation and The Rockefeller Foundation.
Although many foundations are quite significant with considerable assets, staff, and grants going to a plethora of charitable nonprofits, there are also many small family foundations. Indeed, there are far more small foundations than large ones. The Foundation Source says that 66 percent of the 91,000 private foundations in the US have assets under $1 million.
Donor-advised funds are much newer than the foundation model but have become increasingly popular. According to a study by Giving USA, donor-advised funds grew 18.3 percent from 2010 to 2015.
The most substantial national sponsor of these funds, Fidelity Charitable Gift Fund, ranked number one on The Chronicle of Philanthropy’s top 400 public charities and private foundations in 2017, posting $4.1 billion in contributions.
Donors with significant funds to give to charity often wonder which of these platforms, a foundation or a donor-advised fund, would be the most advantageous. Consider the pros and cons of each model carefully.
Pros of Donor Advised-Funds
Easy to set up. Can be opened quickly and efficiently, much like a bank account. Also, DAFs make it easy to track charitable contributions. Everything is in one place with easy access to essential documents.
Low threshold for entry (just $5000 at most funds).
Flexibility and Immediate charitable tax exemption. With the standard deduction going higher due to new tax legislation, donors can front-load a DAF with several years-worth of donations allowing them to itemize beyond the standard deduction (also called “bunching”). Once in the fund, money can be spread over several years and given to any number of charitable causes. Money in a DAF can grow tax-free so that a moderate amount can evolve leading to more significant philanthropic contributions.
Also, donations to the fund can fluctuate to match changes in income. Give more in years when income is high and less in lower income years. Additional family members can be made advisors to the fund so they can participate as well.
Privacy. Donor-advised contributions can be made anonymous, and there is no public documentation.
Advice. Donors enjoy the knowledge held by the sponsoring fund and the help it gives regarding the charitable sector. Also, the sponsoring fund can handle donations of stock, bonds, cash, real estate, and even alternative currencies. Sponsors can convert non-cash contributions to cash and then provide the donor with a range of investment funds from which to choose.
Cost. Donor-advised funds are cost effective. They can be set up with small amounts of money, and administrative costs are low. Donor-advised funds also do not have to disburse a certain amount of money each year (as a foundation must), so a fund can earn interest from its investments before making charitable gifts. However, most administering funds do encourage donors not to “sit” on the funds for too long.
Cons of Donor-Advised Funds
Loss of control. Once given, the donor's money belongs to the administering fund, which then disburses donations/grants for the donor. The administering fund usually adheres to a donor’s requests/advisement unless a chosen charity is not legitimate (not a 501c3). However, the donor loses control of how his/her assets get invested. Also, because the overseeing organization now owns the money, donors cannot make legally binding pledges for future contributions to a charity. They can make non-binding commitments (intent to give).
Potential loss of succession. Donors can specify to whom the account will go after the donor’s death. However, inheritance cannot be prescribed indefinitely. Eventually, funds go into a general pool of money at the administering fund.
Pros of Private Foundations
Control. When an individual sets up a foundation, that person can decide how much money to give, to whom and when. The founder also controls how to invest the foundation's assets. The IRS, however, dictates many rules for disbursing funds, such as the requirement that a foundation must give away at least five percent of its assets each year.
Succession. A foundation can endure for many generations, or spend down its assets in a specified time-limited way
Status. Foundations are not actually “private.” They can become well known, and the charities they help can and do acknowledge them publicly. Thus a family name can be memorialized.
Cons of Private Foundations
Costs and complex setup. Foundations require quite a lot of money and the services of lawyers and financial institutions. It takes considerable time to establish a foundation. Some experts say that one should have at least $1 million to set up a foundation while others advise at least $10 million. However, the Foundation Source, an organization that helps clients set up private foundations, claims that one can be founded for as little as $250,000.
The kicker is that any private foundation must earn enough money to cover its operating costs (estimated at as much as eight percent a year) and still be able to disburse the minimum five percent of assets annually.
Loss of Privacy. Since foundations are 501 (c)(3) organizations that enjoy tax-exempt status, they must be public organizations. Documents about a foundation are readily available to the public. All grants disbursed are public. Anyone can find all the information about a foundation through services such as GuideStar.
Controversies About Donor-Advised Funds
In the last few years, there has been considerable controversy about donor-advised funds. Charities often do not know how to reach donors with these funds, engage them, and influence them. As these funds have grown exponentially, charities worry about losing their base of donors with whom they traditionally have been able to keep close.
Furthermore, since donor-advised funds are not required to pay out any fixed percentage of their assets annually, money can pile up year after year all while earning interest. Those “hoarded” funds are not working for charitable causes even though the donor of the fund was able to take his tax deduction immediately.
One article in the Atlantic that sums up the argument of critics of donor-advised funds said, “Donor-advised fund could best be described as a waiting room for charitable donations.”
On the other hand, one could argue that donor-advised funds allow ordinary folks to start with a small amount of money, grow it tax-free and then give it to charity later, just like prominent philanthropists. Donor-fund sponsors such as Fidelity and Schwab call this the “democratization of philanthropy.” Critics call donor-advised funds “holding tanks” for charitable dollars.
Some research shows that in actuality, about 20 percent of the assets held in donor-advised funds do get disbursed each year. It is not mandated, but the sponsoring organizations typically encourage their clients to give sooner rather than later.
In the end, choosing which vehicle to use for charitable donations, the timing of disbursements, and how much to invest in a donor-advised fund or a foundation should be up to the individual donor or family in consultation with financial advisors and charitable giving experts.
Popular Donor-Advised Funds
Local Community Foundations. Your state or city has one or more community foundations that usually handle donor-advised funds. Search for your community foundation at the Council on Foundations
- Council On Foundations
- Are Donor-Advised Funds a Better Way to Give? The Atlantic Magazine, 2017
- Weighing the Best Vehicles For Philanthropic Giving, The New Times, 2011
- The Data on Donor-Advised Funds: New Insights You Need to Know, Giving USA, 2018
This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.