Have you heard the buzz about Donor Advised Funds?
While Donor Advised Funds’ (DAF) impact on the nonprofit sector has been a hot topic in philanthropy circles, few are offering practical strategies for the 280,000+ donors with DAFs and the thousands more considering this rapidly growing charitable vehicle. Today, one in ten dollars given to charity actually goes to a DAF.
How can donors ensure their DAF benefits — and does not detract from — the critical work of great nonprofits and populations they serve?
Why are DAFs so popular
Donor Advised Funds act like a donor’s own private foundation, but without the significant legal costs or administrative burdens for the donor. An individual contribute assets (cash, securities, bitcoin?) to their DAF and receives an upfront charitable tax deduction — like giving directly to a qualified charity. Over time, the donor makes recommendations to the fund sponsor about which organizations they would like their resources to support. Many organizations offer DAFs — from community foundations to major financial institutions.
According to the National Philanthropic Trust, in 2016 DAFs had combined assets of $85 billion. Contributions into DAFs and grants paid out from DAFs, $16 billion last year, both reached record highs in 2016. They likely broke new records in 2017 (Charles Schwab just last week reported record breaking growth in 2017).
The appeal of a DAF is its simplicity and efficiency for donors in a complex philanthropic environment.
For example, imagine acquiring significant resources — major bonus, sale of a company — and want to thoughtfully invest those resources in great nonprofits, but can’t decide where to give or would like to give over time instead of a one-time contribution. A DAF allows donors to take the tax benefit when it’s most advantageous and then disperse gifts once they have identified specific charitable organizations to support.
Which brings us to the criticism of DAFs.
The DAF Trap
For DAFs to be a long-term positive for the nonprofit sector, donors must actively work to avoid the DAF Trap — parking charitable funds on the sidelines due to indecision and inaction.
Critics charge DAFs take advantage of tax regulation by allowing individuals to receive tax benefits while charitable resources are too often sidelined. Some fear that an increase in DAF contributions will lead to a decline in regular, direct charitable contributions to vital institutions — from museums to food banks to social change organizations — that critically depend on individual contribution. In the Trump era, this concern is doubly compounded by government cuts and new tax policy that removes charitable contribution tax benefits for many individuals by raising the standard deduction amount.
The Trap exists because there are numerous reasons to put the money in, and too few resources to help donors get it out.
Some investment advisors and tax planners are quick to entice their clients with the upfront benefits of DAFs (“takes less than five minutes to set up”), but are not well positioned or incentivized to provide philanthropic resources to help donors thoughtfully disperse their funds. Many of the largest DAFs are operated by commercial firms (Fidelity, Charles Schwab, Vanguard, and Goldman Sachs) that have mixed incentives and only generic philanthropic knowledge to serve their thousands of diverse clients. DAF sponsors also collect management and investment fees, sometimes tens of millions from DAF clients.
From a behavioral standpoint — DAFs front load the financial advantages for donors (immediate tax benefits) and backload the costs (decision making in a crowded, complex environment, investing time and money to thoughtfully identify worthy charities).
That formula can make it hard to get the money out, even for the philanthropically-inclined. Donors may even rationally justify inaction since their DAF may be appreciating through investments.
How to avoid the DAF Trap
Nonprofit leaders are divided if regulation — such as a mandated annual minimum payouts or time limits for funds to remain in a DAF — will prevent donors from falling into the Trap. I believe a more practical approach centers on better educating donors and shifting the conversation away from the upfront tax benefits towards the long-term benefits of more purposeful giving.
Here are some guideposts if you are a donor considering a DAF:
- Despite being en vogue, most donors don’t need a DAF. Their ease of use makes them overprescribed. If there is a stellar organization you already love, give to them directly. It’s inefficient and unnecessary to intermediate such giving through a DAF. As I’ve written before, there is no shortage of worthy nonprofits.
- Be proactive: If you commit to individually research and select nonprofits to support through your DAF, first acknowledge if you have the time and energy to get the information needed to make a decision. Commit to firm goals — such as giving away 25% of your initial DAF contribution annually, to avoid inactive funds. Test the waters — give a few smaller gifts in your first year as a way to get to know some organizations. See what causes and organizations excite and motivate you, and then put more resources behind your favorites.
- Consider a community foundation: If you’re focused on local causes, explore opening your DAF with a community foundation. They typically bring expertise in understanding community needs and relationships with local nonprofits. While their management fees may be slightly more than commercial funds, you’re paying for those donor services — start using them day one.
- Partner with a philanthropy advisor: Even if your DAF sponsor offers generic philanthropy services, consider hiring an outside philanthropic advisor. For example, I work with donors to set a strategy to more purposefully leverage resources around the issues and causes that motivate them. I identify and help vet grantee organizations and facilitate the giving process for individuals and their family. For donors looking for measurable impact on specific issues, a philanthropy advisor can help source and vet opportunities where your resources can achieve a real impact.
Donors find real joy in supporting amazing nonprofits and DAFs can be a productive vehicle for many donors. As a philanthropy advisor working with donors to invest in social change, I support a growing culture of deliberative and thoughtful donors. It can take time for donors to think about their values and the causes that motivate them, and many donors are eager for their money to go further in support of social change nonprofit with outsized impact. DAFs buy you that time, but it cannot be an excuse for inaction.