When families and their advisors contemplate establishing a charitable vehicle, they often compare and contrast the advantages of private foundations (PFs) and donor-advised funds (DAFs). However, for many donors, the best choice isn’t either a PF or a DAF — it’s both. When used in combination, the advantages of a PF and a DAF can be synergistic, providing donors with a full spectrum of options for their philanthropic and wealth-management goals.
These options will change, however, if the recently announced Accelerating Charitable Efforts (ACE) Act becomes law, but for the time being, here are some of the benefits of using these two vehicles in tandem.
While a PF offers more control over grants and almost limitless flexibility for out-of-the-box giving, a DAF enables convenient, anonymous grantmaking. When donors have both vehicles, they have a complete toolkit for achieving their philanthropic goals.
Major gifts. Making a major gift to a favored charitable project or institution represents a significant commitment. To ensure that funds are used according to their wishes, which can include naming rights, donors may want to draw up a grant agreement — a legally binding document — to reflect those details. Because PFs are independent legal entities, they can enter into such agreements, setting forth the purpose, terms and conditions of their grant, with subsequent payments often tied to progress milestones. This option usually isn’t available for DAFs because account holders aren’t agents of the sponsoring organization and can’t enter a legal contract on its behalf.
Balancing transparency and discretion. PFs can’t give anonymously because they’re legally required to record their grants on their tax returns, which must be available for public inspection. In most instances, this transparency is an advantage: In addition to contributing vital financial resources to an organization or cause, PFs can attract public attention (which, in turn, can attract more resources), building awareness and support.
There are situations, however, when giving publicly doesn’t serve the best interests of the donor. Sometimes funders prefer not to have their names associated with a grant, such as when the issue in question falls outside the usual scope of their PF’s mission. (For example, a funder might want to support a local school even though the PF’s mission is global.) To avoid confusing grantees, the donor may elect to contribute from a DAF, which provides flexibility and discretion. And some donors are concerned about having their business or professional reputation linked to a controversial or politically charged issue. Because the sponsoring organization isn’t required to show which grants are associated with each DAF account, a DAF is ideal for making gifts that require absolute anonymity.
Infinite giving options. Whereas gifts from a DAF are typically restricted to straightforward donations to U.S.-based Internal Revenue Code Section 501(c)(3) public charities, a PF provides donors with many more giving options, including:
- Making grants directly to individuals and families facing financial hardship, emergencies or medical distress
- Giving to foreign charitable organizations
- Making loans, loan guarantees and equity investments in support of charitable purposes
- Providing funding to for-profit businesses that support the foundation’s charitable mission
- Setting up and running scholarship and award programs
- Running their own charitable programs
In addition, PFs can reimburse members for reasonable and necessary expenses incurred in pursuit of their charitable purpose, including board meetings, administration, site visits, travel expenses and even costs associated with starting the PF.
Options for enabling discretionary grantmaking. Many donors establish a charitable vehicle for the express purpose of uniting their family in shared, purpose-driven work. But what happens when members either can’t agree on an objective or want to fund their own areas of interest? In addition to granting as a group, some families give their members a portion of funds to donate as individuals. A PF can facilitate this practice of discretionary grantmaking. Alternatively, the family could set up a DAF that members use to fund their side projects. Because neither the discretionary grants nor the grants made from the DAF would be subject to approval by the full PF board, they each could serve as “pressure release valves” when individual interests threaten to derail mission and unity.
While PFs can be funded with and hold a wide array of assets, DAFs provide a higher tax deduction for contributions as well as a higher total limit for combined annual contributions. Combining the two can return the best possible financial outcome for the donor.
Maximizing tax deductibility. The maximum that a donor can contribute to a foundation is 30% of the donor’s adjusted gross income (AGI). However, donors who’ve had a significant liquidity event may want to exceed that limit. Because contributions can be made both to a PF and a public charity in a single year, additional cash contributions of up to 30% of AGI can be made directly to one or more public charities, including DAFs. By “stacking” contributions to a DAF and a PF, donors can effectively maximize their deduction. Note that the temporary suspension of the AGI cap on charitable deductions that applied in 2020 has been extended through 2021.
Funding with alternative assets. PFs can own nearly any type of asset, including partnerships, real estate, jewelry, closely held stock, stock options, art, insurance policies and other valuables. A DAF may limit investment options to cash equivalents, publicly traded securities, and shares of mutual funds. Donations of real property and nonmarketable securities typically are sold or liquidated by the sponsoring organization.
A DAF offers fair market value for a donation of long-term capital assets (for example, real property, notes and privately held stock), whereas a PF provides cost basis. However, because a PF can hold onto these assets and even put them to charitable use, there are other possibilities to consider.
Because no one can predict their future needs with certainty, establishing both a PF and a DAF provides maximum flexibility. Whereas DAF-sponsoring organizations’ policies typically ensure that family control over a DAF eventually sunsets, a PF is an independent legal entity, and control of its assets can be transferred from the founding generation to the next in perpetuity.
Finally, having both a PF and a DAF is ideal for donors to future-proof their philanthropy. Should a PF prove too cumbersome over the long haul, the assets can be transferred to a DAF. However, should a DAF prove too limiting, it’s all but impossible to do the reverse. Although DAF-sponsoring organizations are permitted to make grants to PFs, most have internal policies prohibiting such distributions. By having both, should donors outgrow their DAFs’ philanthropic and investment options, they can turn to their PF. And should their initial forays into philanthropy, typically begun with DAFs, turn into either a second act for a retired donor or a family enterprise that includes the next generation, their PFs can serve as an enduring legacy.
Mary Ann Stover is the chief revenue officer at Foundation Source, which provides comprehensive support services for private foundations. The firm works in partnership with financial and legal advisors as well as directly with individuals and families.