Donor-Advised Funds: Analysis of the Current Landscape

Scott Middleton, CFA, CIMA® | Principal and Director
Zach Heath | Analyst
Joshua Shapiro, MBA | Analyst Assistant

Donor-advised funds (DAFs) have become a popular way for individuals and families to facilitate their charitable giving. As of 2018, it was estimated that DAFs held more than $121 billion in assets and distributed in excess of $23 billion to nonprofit organizations. Numerous organizations have established DAF structures, including community foundations and charitable organizations formed by investment management firms, such as Vanguard and Fidelity. Individuals can create their own DAFs within these organizations to receive donations of either cash or appreciated securities, invest the proceeds, and make distributions to nonprofit organizations. DAFs are essentially funding accounts set up by an individual through a charitable sponsor.

Investments Options for DAFs

Charitable sponsors of DAFs allow donors to choose how their contributions are invested. For example, Vanguard Charitable and Fidelity Charitable provide a wide selection of investment options, including proprietary active or passive funds, model portfolios or individual investments, and ESG (environmental, social and governance) or SRI (socially responsible investing) mandates. Smaller organizations, such as the Catholic Foundation of Northern Colorado and the Denver Foundation tend to have more limited investment choices. Further, the Catholic Foundation provides investment options that screen out individual companies whose business models do not align with the Catholic faith. The Denver Foundation provides a long-term balanced pool, SRI portfolio, passive portfolio, and an impact-mandate portfolio. Both the Catholic Foundation and Denver Foundation use third-party investment firms to assist in designing the portfolio and selecting investment managers.

Donation Restrictions and Screens

It is essential for donors to understand that when creating a DAF through any charitable sponsor, they are donating directly to an independent, charitable organization. When assets or cash are contributed to a DAF, the donor relinquishes control as to which organizations may subsequently receive support from their account. The donor typically makes recommendations to the charitable sponsor as to which organizations they would like to have receive donations from their DAF account. The DAF sponsor has ultimate discretion to make or prohibit donations to each charity. The donor is only able to recommend to the sponsor which organizations that he or she would like to receive donations.

Why are donation requests restricted or screened by DAF providers?

Some DAF providers have clearly stated morals, values, and/or religious beliefs that lead to restrictions on the organizations that may receive distributions from donors. For example, a DAF held with the Catholic Foundation of Northern Colorado will not be able to make donations to nonprofits that oppose the foundation’s core beliefs, such as pro-abortion organizations.

Other DAF providers may or may not inform donors in advance that certain types of organizations will be prohibited from receiving distributions. Of the multiple reasons that charitable sponsors may have to restrict or screen certain donations, the most common reasons are when a nonprofit’s tax-exempt status is under consideration to be revoked by the IRS and/or there is outstanding litigation against the organization. Additional and more complex screens include concerns related to nonprofits’ lobbying, political orientation, and moral and religious values. Some sponsoring organizations use outside resources to assist them in their screening process. These outside resources may have inherent political, moral, social, or religious biases. For example, Fidelity Charitable considers the input of outside resources when restricting donations to organizations deemed as “hate groups” or having “harmful” causes.

DAF providers restricting charitable distributions have sparked notable controversy throughout the industry, especially when donors are not clearly informed in advance of the sponsor’s screening philosophy and process. Restricting and screening donation requests has become more prevalent as charitable organizations have increasingly adopted distinct political, moral, and ethical philosophies.

Private Foundations

A more comprehensive, but less accessible, channel to donate is through a private foundation (PF). A PF is an independent legal entity, set up by an individual, family, or corporation, solely for charitable purposes. Through a PF, donations can be made to wide array of charitable options.

PFs are more suited for ultra-high-net-worth families and individuals who seek a higher level of control and can afford the substantial costs associated with setting up and managing an independent legal entity. The substantial costs associated with a PF include, but are not limited to, the legal and administrative costs to start a foundation, ongoing legal fees and tax filing costs, excise taxes, in-house staff, rent, travel, accounting, and the administration of considering grants and making required annual distributions. In addition to these costs, donations made by a PF are public, which eliminates the option to anonymously donate.

A PF is a distinct legal entity, whereas a DAF is more appropriately considered as an account held with a sponsoring charity in the name of the donor. Due to the structure of DAFs, the donors are subject to the charitable sponsor’s 501(c)(3) guidelines or screens. By contrast, a PF offers a spectrum of giving choices because it is structured as an independent corporation or trust. These charitable giving choices include grants to 501(c)(3) public charities, individuals determined to be in financial need, scholarship programs, and others.

Tax deductions are another point of distinction. Tax deduction for gifts of cash are limited to 60% of adjusted gross income (AGI) for DAFs, and 30% of AGI for PFs. Tax deduction for gifts of stock or real property are limited to 30% of AGI for DAFs and 20% of AGI for PFs. Further, DAFs are not required to make distributions, while PFs must distribute five percent of its net assets each year, regardless of how much the assets may earn.

Conclusion

Charitable giving of all types provides individuals and their families a platform to give back in a way that not only benefits themselves, but also their community and the causes to which they are committed. A clear understanding of a charitable sponsor’s investment options, investment screens, donation restrictions, and other factors can help simplify and enrich the giving experience.