Donor Advised Funds: The Good, the Bad and the Ugly


by Rhode Warrior Blogger, Mark Noll

When someone mentions the brokerage and banking firm, Charles Schwab, it is unlikely that one thinks “philanthropy.” But Charles Schwab, along with Fidelity and Vanguard are now three investment firms whose charitable divisions are listed in the top ten of the Chronicle of Philanthropy’s 2014 Philanthropy 400. As a result of their Donor Advised Funds (DAF), these three financial-services firms stand out in stark contrast when listed among more familiar charitable organizations such the United Way, Salvation Army, Goodwill Industries and the American Cancer Society.

Donor Advised Funds are not the “new kid on the block.” They have been around in some form since the 1930’s. For-profit financial investment firms saw an opportunity and jumped into the DAF game in the 1990’s establishing affiliated nonprofits to maintain donor-advised fund accounts. Over the past ten years, these commercially based DAF’s have grown exponentially.

The fifty or so commercial DAF’s in existence today continue to rise to the top of the Philanthropy charts. In fiscal year 2013, Fidelity showed a growth of 11.9% and had a total income of just under $4 billion dollars. Charles Schwab had an increase over the previous fiscal year of a staggering 165.2% placing it fourth on the list.

Donor Advised Funds have now evolved into the preferred choice of giving vehicles among the wealthiest of donors. The National Philanthropic Trust found that in 2012 the average size of donors’ accounts was nearly two hundred and twenty-five thousand dollars.

Whether you like DAF’s or not, truth is, they have taken center stage in the world of philanthropy and cannot be ignored. When looked at from the eye of a charitable organization, Donor Advised Funds carry with them both advantages as well as disadvantages.

The Good

For the investor/donor, Donor Advised Funds play a vital role in simplifying their charitable donations in any given year. Whether it is through an investment firm, community foundation or other source, the DAF allows the investor/donor to set aside a sum of money and receive a single source tax deduction for that year. Later on, the donor can simply direct these funds to their favorite causes.

To sweeten the pot, contributions to a DAF provide the donors better tax options than contributions to a private foundation. Donor Advised Fund contributions are considered donations to a public charity and as a result, can be claimed at a higher charitable contribution deduction (up to 50% of adjusted gross income) as opposed to a 30% deduction to a private foundation.

The simplicity of a single tax deduction as opposed to a compilation of various charitable tax receipts simplifies the donation process. Combined with the luxury of having ample time to direct these funds to their favorite charities and one can see how a Donor Advised Fund makes for a win-win situation for the both the investor/donor and the sponsoring DAF.

Other benefits for the donor include estate planning benefits, lower start-up costs, and lower expenses in connection with legal, administrative, and accounting services to establish and maintain donor-advised fund accounts as compared to private foundations.

It also can be argued that DAF’s ultimately benefit charitable organizations by assuring that eligible tax deductions are not disregarded. Were it not for the ease with which one can make contributions to a Donor Advised Funds, how many tax deductible giving opportunities would otherwise have been lost? The simplicity of a “one and done” donation process basically assures that potential donations don’t fall through the cracks at the end of the tax year.

The Bad

One of the advantages of a private foundation over a Donor Advised Fund is that the Foundation exercises 100% control over how the gifts will be distributed. The Donor Advised Fund contributor can only advise how the funds should be allocated and does not have control of the money (wink, wink). I’ll leave it at that.

Another problem is with transparency, or lack thereof. DAF’s are the only charitable-giving vehicle that allows donors to make grants 100% anonymously. As nonprofit research departments review donations to other organizations, they may well see that a gift was made to a particular charitable organization from a DAF but the source behind the DAF contribution remains completely confidential. The DAF acts as a virtual smoke screen for the contribution.

And then there is the contention that the way donor advised funds are set up, it makes it harder for a nonprofit to engage potential donors and establish a closer relationship. One can disagree with this statement since most organizations target donors to a DAF knowing that they have both wealth and charitable funds available. But again, DAF’s can build a wall between the donor and the charitable organization which hinders such other benefits as volunteers and board memberships.

The Ugly

Despite the arrangement that all contributions to a Donor Advised Fund make their way to a charitable organization over time, there is no immediacy to do so within an allotted period of time. To take this one step further, there really is nothing that prevents these intended donations from being held by the DAF in perpetuity. Not that that is the case, but the potential exists.

Due to the fact that there is no mandate on the part of the DAF to direct these funds to a nonprofit, it allows these “charitable contributions” to be invested and gather interest. For the commercially sponsored DAF’s these funds are simply another revenue stream. One can point to the fact that this is nothing more than hijacking well intended funds in the name of profit; that these investment firms have found a way to infiltrate the philanthropic world to their advantage. But in all fairness, that can be misleading.

Most DAF management fees amount to about 1 percent of the assets under management which constitute a very small fraction of the firm’s revenues. Yes, money is being made here but it is a small amount when overhead expenses are considered. Bottom line is that the profit yield is very low by investment industry standards.

More importantly to the investment firms, through their Donor Advised Funds, they have opened up a line of communication to wealthy individuals that otherwise may not have occurred. Despite this, the fact cannot be lost that commissions are being paid to financial advisers which raise an ethical question in terms of philanthropic funds being used for profit.

Then there is the issue surrounding of gifts sitting idle in a DAF while smaller charities have an immediate need for donations. Struggling food banks and other charities that function more on a day-to-day basis are not seeing the potential donations resultant from a rising stock market. Instead, these desperately needed funds sit in an investment somewhere while urgent needs may go unfulfilled.

How long these funds sit in the accounts of the DAFs is debatable. The problem isn’t THAT the funds will be allocated; it is WHEN the funds will be allocated. Given such, we cannot help but see DAF donations being issued to charities much in the way sand passes through an hourglass.

This has not gone unnoticed. There has been talk in Washington of requiring Donor Advised Funds to allocate a minimum 5% in a given year much in the way private endowed foundations are required to do so. But there are two problems with this concept. The first problem is that these Donor Advised Funds are already allocating somewhere between 15 to 20% to charities.

The second problem is that 100% of the funds held in a Donor Advised Fund are intended to given to charities unlike a foundation where an endowment is invested and the income from the endowment is paid out annually to charity. Fact is, the 5-percent minimum imposed on foundations in the 1969 tax law was based on the idea that foundations should be allowed to operate in perpetuity. That is the polar opposite of the intent of contributions to a Donor Advised Fund.

Living With Donor Advised Funds

Much like the annoying bass line coming from your neighbor’s house, Donor Advised Funds are something we need to simply live with, good, bad or ugly. As fundraisers, we toss around the word “donor-centric” as part of our vernacular. Well to a high net worth individual, there likely is not anything more convenient than a Donor Advised Fund. They are much more convenient than establishing a trust or setting up a Foundation. As a result, philanthropists are finding them as the vehicle of choice for their charitable giving.

Donor Advised Funds allow for a well calculated disbursement of funds rather than a knee-jerk reaction given the limited time imposed by traditional vehicles for donations. Best of all, it allows the Philanthropist one simple and easy way to receive a tax write-off in a given year. With all these benefits, why would DAF’s not continue to grow over the upcoming years?

Fidelity’s DAF will likely overtake the United Way in very near future in the Chronicle of Philanthropy’s Philanthropy 400. Investment firms have positioned themselves effectively as the “go to” middleman in a world where no middle man should exist.

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About the Author

Mark Noll is an Advisory Board Member of The Prospect Research Institute and Associate Vice President of Research and Development Services at the University of Rhode island Foundation. A member of AASP as well as APRA, he spends his free time at Starbucks and excels in the art of mediocrity.