Category Archives: Education

The Advantages and Potential Drawbacks of Donor-Advised Funds

The Advantages and Potential Drawbacks of Donor-Advised Funds

While most people probably think of philanthropy as direct gifts to charities and nonprofit organizations, there are several financial vehicles that can help individuals make donations. One of the most prominent vehicles for people with significant wealth is a foundation. However, several other options are worth considering as well. Another potential option is a donor-advised fund, which offers some tax benefits and allows donations to be pooled and invested, potentially creating a larger impact.

With a donor-advised fund, money earmarked for contributions to 501(c)(3) public charities are invested by the fund for tax-free growth. Donors to these funds provide guidance on which charitable organizations should receive grants from the fund. Individuals can also choose how their donations are invested, so that their contribution can grow as they decide which charities they want to support. The initial donation to the fund is tax-deductible and all growth is free from any tax liability.

Donor-advised funds have been in operation since the 1930s, although the legal structure by which they now operate was not officially created by Congress until 1969. These funds have been growing in popularity since the 1990s, although the general public tends is less aware of them. In recent years, they have emerged as the fastest-growing vehicle for donations. Today, about 3 percent of all charitable gifts come from these funds. While donor-advised funds have some obvious benefits, they also pose some clear issues for the philanthropy sector.

When Are Donor-Advised Funds Appropriate?

People may choose to contribute to donor-advised funds rather than making a direct donation to a charity for a variety of reasons. For example, suppose that a wealthy individual has a very financially successful year and wants to support a few charities. These organizations are small and lack the infrastructure necessary to handle large donations effectively. By contributing to a donor-advised fund, the person can make five smaller grants instead of one large donation, with the added benefit of tax-free growth potential that could increase the impact of their donation.

In this situation, some people may suggest creating a private foundation, but this structure faces a 30-percent limitation for gifts and thus would not provide the same tax deductions as a donor-advised fund. In addition, private foundations require significant time and expense to establish and manage. On the other hand, a donor-advised fund is run by an entity that is technically classified as a public charity, although they are typically affiliated with major finance companies. The donor’s tax-deductible contribution is made to this entity, which then disburses grants to charities according to donor guidance. Donors should note that these entities are not obligated to follow their suggestions, although they have a strong incentive to do so—the resulting bad press would dissuade others from contributing to the fund.

The other major advantage of donor-advised funds is that the donation to the charity comes from the fund, not the individual. In this sense, the donation can be made anonymously, which is preferable for some donors.

What Are the Downsides of Donor-Advised Funds?

While donor-advised funds offer several benefits, they also have some downsides that philanthropists should consider. Perhaps the biggest issue with this type of vehicle is that it is not obligated to make a certain number of disbursements each year. Private foundations must distribute at least 5 percent of their assets each year, but donor-advised funds are not subject to this regulation. Sometimes, the managers of these funds encourage people to let their donations sit in the fund and grow, rather than grant them to charitable organizations. In this situation, the donor may begin to think of their gift as less as a donation and more as an asset that needs to be protected. As a result, the donor can become less likely to authorize the donation. Behavioral economists have coined the phrase “the endowment effect” to describe this behavior.

Individuals should keep in mind that the managers of donor-advised funds are not truly charitable foundations themselves, but rather organizations established by large financial management companies. For example, Fidelity Charitable is one of the largest recipients of donations as a donor-advised fund. However, $4.6 billion came into Fidelity Charitable in 2015, according to tax records, but only $2.8 billion was disbursed to charities. Altogether, Fidelity Charitable has about $15 billion under control. This sum essentially represents donations that are being kept away from charities that could benefit from them.

Donors have the ability to direct their investments in donor-advised funds and typically receive regular statements about how the investment is growing. These statements can encourage a feeling of ownership over the money, even though the donor won’t receive anything back and the funds are intended for charity. Ownership feelings lead to the endowment effect. The matter becomes even more complicated because donors can pass their accounts to children and grandchildren to create a charitable legacy. Donor-advised funds have an incentive to encourage hoarding behavior, because they can collect management fees for longer periods of time.

The Bottom Line

When it comes to donor-advised funds, the bottom line is that these vehicles have some serious tax advantages that can make them more appealing than other options, such as foundations. At the same time, individuals need to make sure that contributions to donor-advised funds are actually granted to charities. While it can be tempting to see how much the money can grow, funds that sit in an account will not make a real impact.

The Debate about Charity Overhead – What You Need to Know

The Debate about Charity Overhead – What You Need to Know

The debate about charity overhead is often in the news these days. For example, the Wounded Warrior Project fired its top two CEOs last year after it deemed a million-dollar meeting was entirely too extravagant. Only a few years ago, Dan Pallotta gave his famous TED talk entitled The Way We Think About Charity Is… Continue Reading

The Inherent Problems with Ratings from Charity Watchdogs

The Inherent Problems with Ratings from Charity Watchdogs

A number of watchdog organizations exist that monitor and rate nonprofit organizations. Some of the largest ones include CharityWatch, GuideStar, the Better Business Bureau Wise Giving Alliance, and Charity Navigator. However, a number of newer groups, such as GreatNonprofits and GiveWell, have gained significant momentum in recent years. These organizations offer their own breakdown of… Continue Reading

5 Ways to Make Your Charitable Giving More Tax Friendly

5 Ways to Make Your Charitable Giving More Tax Friendly

When it comes to charitable giving, choosing a charity is only part of the process. In fact, there are a number of different approaches to philanthropy, and individuals need to consider all the possibilities before they decide on the best one for their personal needs. Thinking critically about the tax consequences of each strategy can… Continue Reading

The American Red Cross – A Critical Disaster Response Organization

The American Red Cross – A Critical Disaster Response Organization

The American Red Cross plays a critical role in maintaining public health and safety, both at home and abroad. When people think of the American Red Cross, their thoughts likely turn to blood donations or CPR training. Indeed, the organization plays a critical role in collecting blood donations to aid in lifesaving treatments at hospitals… Continue Reading

This Is How the Wounded Warrior Project Supports Veteran Reintegration

This Is How the Wounded Warrior Project Supports Veteran Reintegration

Wounded Warrior Project is one of the highest-rated organizations on Charity Navigator in terms of accountability and transparency. The organization offers a wide range of services for veterans and their families, including assistance with the transition from military to civilian life. While serving, many people are put under an enormous amount of pressure. They can… Continue Reading

World Vision Aims to End HIV Among Adolescent Girls by 2030

World Vision Aims to End HIV Among Adolescent Girls by 2030

Dedicated to giving back to the community, Eugene Chrinian provides support to a number of charitable and nonprofit organizations working at home and abroad. One of the organizations that he supports is World Vision, a nonprofit that aims to protect and improve the lives of children around the world. One of the major goals of… Continue Reading

Improving Succession Plans in the Nonprofit Sector

Improving Succession Plans in the Nonprofit Sector

Succession planning is an integral strategy for organizations of any type, but for the charity sector its importance has grown tremendously in recent years. Expansion of existing nonprofits and the introduction of many others have presented a need for addressing the issue of when and how to pass on the leadership torch. A well-executed succession… Continue Reading

7 Big Charter School Achievements Backed by Philanthropy

7 Big Charter School Achievements Backed by Philanthropy

The link between philanthropy and charter schools extends back to the advent of the latter, in 1991. During the last 25 years, the charter school system has grown from its roots in Minnesota to include the District of Columbia and 43 states. Largely supported by foundations and other philanthropic sources, charters outpace all other educational… Continue Reading

6 of the Top Institutions for Philanthropy Research

6 of the Top Institutions for Philanthropy Research

Though Andrew Carnegie and John D. Rockefeller stood out as among the most generous philanthropists of their day, today they would be just two of the hundreds of active donors giving at their level. This trend has driven universities to begin establishing programs for the study of philanthropy, a social and economic phenomenon of multiple… Continue Reading