Nonprofits are probably most familiar with donor-advised funds (DAFs) at community foundations: a donor gives, let’s say, $1 million to a community foundation and gets a $1 million tax deduction that year. Over the next several years, the donor “advises” the foundation to pay out the $1 million in grants to various nonprofits that the donor selects. Donor-advised funds are also administered by commercial institutions such as Fidelity and Chase. Writer Jeff Angus took a closer look at DAFs for Blue Avocado:
In 2009, the last tax year that the IRS has available statistics, donor-advised funds (DAFs) represented a sharply growing share of a diminishing giving pie. While the amount of total giving went down by 8%, the amount of giving to donor-advised funds went up by 9%.
We shouldn’t be surprised. Through a tempting set of tax benefits and social advantages, donor-advised funds are believed to “incentivize” charitable giving. But while donors get to pick from a smorgasbord of benefits, nonprofits have to struggle even to find out who are these prospective funders.[See sidebar "Donor-Advised Funds Background” for more information.)
While the largest donor-advised fund managers are commercial investment companies, such as Schwab and Fidelity, nonprofit organizations are typically more concerned with the donor-advised funds at community foundations. At most community foundations, the bulk of incoming dollars arrive via DAFs and go out from DAFs. For instance, the Orange County Community Foundation (in California) made $26 million in grants in 2010, but $24.5 million of this was distributed from donor-advised funds (in other words, only $1.5 million was granted based on decisions made at the foundation’s discretion).
Although many nonprofits bemoan donor-advised funds as foundations that are tantalizaingly just beyond reach, the sector’s overall view of DAFs is accepting, even enthusiastic about this increasinglyl important mechanism for giving. Even professional skeptic Rick Cohen (who also writes for Blue Avocado) recently wrote that the financial giants, such as Fidelity, Vanguard and Schwab, do not appear to be corrupting charitable aspirations with corporate agendas: They have actually made establishing charitable funds easier for less-than-rich crowd ("Overcoming Outmoded Skepticism: Seeing National Donor-advised Funds for What They Are,” Nonprofit Quarterly, April 2012).
Why are donor-advised funds so appealing to donors?
The DAF, as a ubiquitous financial product, truly does encourage donations, according to one of its most vocal critics, tax expert Professor Ray D. Madoff (no relation to notorious Ponzi schemer Bernie Madoff) of Boston College Law School. While Madoff believes that DAFs stimulate giving, she also notes that the regulations allow donors to deduct charitable giving when most convenient, but they do not ask for enough in return.
A hundred critics have pointed out a hundred unrequited advantages given to DAF users. To summarize:
- Taxpayers can deduct in the year of their choice without a working nonprofit actually receiving any money.
- Unlike donating to a "regular” nonprofit, DAF-fers get deductions for the full fair market value of real estate and illiquid assets (such as art work).
- More money (a higher percentage of total personal income) can be given and deducted if it’s given to a DAF rather than a private foundation.
- The freedom to transfer money, deductibly, to foreign charities.
- No imposed payout requirement, meaning technically, a DAF account could be like a Roach Motel, with donations going in but never coming out.
- The transparency-snuffing privilege of donating anonymously.
While the last benefit — anonymity — is not unique to the DAF product, it is an extra perk that is highly valued by some:
"I was talking with a college friend recently and he told me this was the reason he was giving through a Donor-Advised Fund,” Madoff explained. "People like the lack of transparency…you get the deduction, you don’t have to put it to use and it’s kept secret from charities that might want to make petitions shielding you from ‘being bothered’,” he added.
The not-so-secret social benefit
A potent side-benefit to DAF givers transcends tax deductions: it can be a red carpet walk to join the cool people who get to do cool things together, like a Davos confab without the travel expenses.
"A local community foundation approached me to set up a Donor-Advised Fund with them, and it would give me social benefits that the same amount of money put into direct funding wouldn’t,” explained a major donor who asked not to be named here. "With a community foundation, you get invited into a social circle and be part of a cool club,” she added.
Further, the community foundation profiles DAF donors in its annual report, adding luster to the giver’s personal brand, and invites them to special events with the donorati, neither of which would likely be offered with a comparably-sized direct donation to an individual nonprofit.
Oversight challenge begs redesign
For smaller community foundations, donor-advised funds may be time-consuming to manage (because the donors may be demanding). They usually "have a hard time turning down the money, even if it comes with a lot of friction,” according to Sturgis Robinson, former Executive Director of the Orcas Island Community Foundation. They had about $5 million in assets during his tenure. Community foundations typically provide several donor services to DAF-ers, some of which can create friction between the donor and the foundation staff:
- Investment management: while some donors are glad to have the foundation choose the investments made by the DAF money, others insist on having a a hand in where their DAF funds are invested, perhaps in their own company or the company of a friend. Large DAF donors are prone to complaining about the returns on the investments of their DAFs.
- Identifying nonprofits: some DAF donors ask for foundation advice in finding, for example, a worthy local after-school program. In other instances community foundations "pitch” their DAF donors to no avail. Another might ask the community foundation to check into the bonafides of a nonprofit for whom they are considering a gift.
- Oversight: some community foundations do not allow DAF contributions to be made to special events, such as $5,000 to a Sponor Level at a fundraising gala. The foundation’s rationale is that a portion of that ticket is not tax-deductible, although the donor got the full tax deduction when the gift was made to the DAF. Some donors find this restriction rankling (there is effetively no such restriction at the Fidelities of the world).
- Suspicious giving: community foundations sometimes sniff something off when, for instance, a donor directs a large grant to a nonprofit founded by the donor’s son. At Orca, for instance, Robinson’s attention was drawn to an odd donor recommendation that made him invest more time inspecting the donation. (Again, such sniffing is probably less common in larger institutions and pretty much nonexisent at the commercially-based DAFs.)
Do DAF fees cover the foundation’s costs?
Community foundations (and public foundations such as a women’s foundation, a GLBT foundation or an Asian fund) have varying rates for the fees charged to donor-advised funds; some have sliding scale fees as well. A larger community foundation may charge .05% of assets, while a smaller one may charge 1.75%. In contrast, Fidelity charges .6% on the first $500,000 in deposits and .15% on deposits of $2.5 million (above that fees are negotiable). In other words, a donor-advised of $1 million might pay an annual fee of somewhere between $1,500 and $5,000.
When trying to get a donor to place a DAF with their community foundation, foundation staff tend to emphasize personal service and to be apologetic about fees. At least one analysis by the Foundation Strategy Group for a community foundation showed that in aggregate, DAF fees were not covering DAF costs. In effect, the foundation was using unrestricted funds to subsidize the donor-restricted funds.
But a consultant to community foundations, Alan Pardini, says, "It’s not fair to say that donor-advised funds don’t pay for themselves; it depends on the institution.” He goes on to say that while the breakeven point depends on the fees charged, the scale, and the level of service provided, for many community foundations, the DAF "business model may be broken.”
Sharing May Be Caring
While community foundations and other organizations that manage DAFs might have legitimate concerns about the cost of acquiring and managing DAF-fers, the best data available, while inconclusive, indicates that donors, overall, are not simply allowing the money to sit:
Specifically, Fidelity reports giving in composite as regularly being over 20% of assets each year. The National Philanthropic Trust (NPT) (also in the DAF administration trade) study, roughly contemporaneous and that includes Fidelity within their 478 DAF sponsors, asserted that giving from 162,000 DAF accounts was around $6.2 billion out of assets of $30 billion, lower than Fidelity’s composite, but still over 20%.
That commendable output easily outstrip the 5% floor required of other forms of giving in aggrage, but does not assure that tens of thousands of DAF accounts met a 5% standard. The mean may not be the functional average here, and for now, the numbers that Fidelity, NPT and the IRS deliver may provide some general comfort about DAFs’ generosity as a block, without accounting for the number of cases that donate 5% or anything at all, it’s not actually accountable.
Until the IRS reports consolidated numbers in more detail and less vintage than 2006 (they had a chance to for this article but declined to provide them by deadline), or unless DAF charitable sponsors, currently without any incentive to willingly report how many DAF-fers give what percent of their assets each year, accountability is denied taxpayers and public charities alike.
This DAF design, that, as Professor Madoff has suggested, seems asymmetrically beneficial to donors and operates with minimal sunlight. It is not likely to change. Congress had its bite of the apple and came up with charitable-giving bits of the 2006 Pension Protection Act. They didn’t address any of the key disconnects.
The fact that donor-advised funds are both mostly non-transparent and one of the fastest-growing paths for directing funds towards public charities may be a losing proposition even if the nonprofit sector has no leverage over them. Dare we call them unbalanced, demented, or perhaps even DAF-fy?
Jeff Angus is a writer, data analyst and management consultant based in Seattle, Washington. He has worked in government, corporate technology, and the nonprofit sector, and is an active member of the Society for American Baseball Research. He has never figured out how to make his daughter’s or grandchildren’s wallet extraction protocol be donor-directed; they are always, tragically, donor-advised.