Though there’s been an explosion of new donor-advised fund (DAF) accounts that have opened in the past decade, many attorneys, accountants and financial advisors report that some clients still come to them and state that they want to create a private foundation (PF). Once they’ve listened to their advisors, however, far more clients open up DAF accounts instead.
There are still some donors who should and do create PFs, but the numbers indicate that few PFs are created today and that DAFs have become the dominant charitable vehicle. Ten years ago, there were approximately 75,000 PFs and 150,000 DAF accounts, but currently the PF numbers have barely increased to 82,000, while there are now 463,000 DAFs, according to the latest NPT study.
While attorneys and advisors 10 or 20 years ago felt that clients should perhaps consider PFs if they would initially fund them with $1 million, $5 million or $10 million, today most advisors indicate that a client shouldn’t begin to contemplate a PF unless he would fund it with at least $10 million, $20 million or $50 million. Even at those and higher levels, many, if not most, advisors still recommend creating a DAF unless there are compelling reasons to create a PF.
Conversion to DAFs
As awareness of DAFs has increased rapidly among donors who already have PFs, many of them are closing and converting their PFs to DAFs or are establishing DAFs to complement their PFs. Foundation Source indicates that 88% of PFs are below $5 million and two-thirds are below $1 million, but it’s quite possible that many of these were opened when PFs were popular in the 1990s and early 2000s.
Donors increasingly realize, often with the help of their advisors, that they can accomplish their charitable goals through a DAF for significantly less cost and can reduce the burden, responsibility and complexity of operating the PF.
There are philanthropic advisory firms that can help PFs manage the administrative aspects and protect them from any wrongdoing or Internal Revenue Service penalties or fines, but these firms also help many DAF donors achieve their charitable goals. Many DAF sponsors provide helpful content and advice to their donors and can connect their donors to these philanthropic advisory firms when appropriate.
Benefits of Charitable Vehicles
There are many advantages for donors to create a charitable vehicle, regardless of whether it’s a DAF or PF. These include:
- They can donate assets to the vehicle and receive a tax deduction in the year of the donation.
- If donors have a liquidity event or large income in a particular year, or they’re approaching retirement while continuing to earn a big paycheck, they can donate to the vehicle to receive a significant tax benefit and make grants in subsequent years when their income is less.
- Donors may not want to donate too much to a charity at one time.
- Donors can continue to grant consistent amounts from their vehicle even when their income or investments drop in value in certain years.
- Charities are often unable to accept donations of complex assets, and it’s cumbersome for some to accept even publicly traded stock. Charitable vehicles, especially DAFs, regularly accept illiquid assets.
- Vehicles can be used to help teach philanthropy and pass on family values to children and heirs and keep the family united for the future.
- Donors may want their giving to continue with future generations.
- Vehicles can enable donors to more easily keep track of donations and grants to and from the vehicle.
Benefits of PFs
Some donors still feel more comfortable in opening PFs for some of these reasons:
- Grants are assured, not recommended, though most DAF sponsors approve nearly all grants.
- They aren’t concerned about costs, complexity, or IRS oversight or may desire the perceived status of having a PF.
- They can pay for expenses and hire and pay for staff, including relatives, though the IRS can review.
- PFs can grant to individuals in case of hardship if IRS criteria are met.
- PFs can allow for more control over investment options, though many DAF sponsors now allow for outside financial advisors to manage assets at certain minimum levels (American Endowment Foundation at $10,000, Fidelity and Schwab at $250,000, Community Foundations often at $500,000 or $1 million).
Benefits of DAFs
Yet far more often these days, donors decide to open DAFs instead of PFs because:
- There’s no cost to open a DAF and minimal annual fees, while PFs are expensive to create and maintain.
- DAFs can be opened within days while PFs can take months.
- Clients can receive a significantly higher tax deduction for donating certain assets to DAFs (that is, cash donations are deductible up to 60% of adjusted gross income (AGI) for DAFs versus 30% for PFs, and other assets are deductible up to 30% of AGI for DAFs versus 20% for PFs).
- Donors are generally entitled to a tax deduction of the full fair market value of a donation to a DAF for many complex assets, instead of the original cost basis that would be applicable to a PF.
- There’s no required annual tax filings for DAFs while PFs must file annual complicated 990PF and state filings.
- There’s no tax on investment income in DAFs, while PFs are subject to excise tax of 1%-2%.
- DAF donors’ anonymity is assured if desired, while all PF grants can be viewed by the public and other charities.
- DAF sponsors handle all grant administration, while PFs must be responsible for their own.
- Donors want the simplicity that DAF sponsors provide as they’re easy and efficient to use.
- Many DAFs offer online granting and viewing of past grants and donations, while many PFs don’t or must pay for this ability.
- DAF sponsors are responsible for complying with the laws, thus relieving donors of this burden. PFs must keep official meeting notes, provide compensation benchmarking backup to IRS to justify salaries paid to family members, carry various types of insurance for board members and ask trustees to sign conflict-of-interest statements.
- There are no minimum annual distributions for DAFs, compared with a 5% minimum for PFs.
Discuss Charitable Goals
Clients are best served when their advisors discuss their charitable goals. They can help determine their clients’ desire for simplicity or tolerance of complexity, the time frame for giving, who’ll be involved, how much clients want to invest in a structure for their giving and why they want or need a charitable vehicle.
Advisors should discuss what’s worked well for their clients in the past and what’s been a cause of frustration or concern. For clients who need absolute control and don’t mind all of the regulations, requirements, responsibilities and costs, a PF may be the best choice. If clients primarily want to efficiently make grants to their favorite charities, are cost-conscious, desire simplicity and, perhaps, can’t even keep track of where or how much they’ve previously donated or can’t find the tax receipt letters they’ve received, opening a DAF is most likely the best solution.
Ken Nopar is the senior philanthropic advisor for the American Endowment Foundation donor-advised fund.