The percentage of rich people in America has risen substantially over the past several years. According to Credit Suisse, there were over 243,000 ultra-high-net worth individuals with net worth above $50 million at the end of 2022. The same shown showed there were over 59 million millionaires at the end of 2022 with just under 23 million of these individuals being from the United States.
Many are turning todonor-advised funds(DAFs) to assist with their charitable efforts, and the numbers are not only increasing but are impressive. According to National Philanthropic Trust, grants from DAFs to qualified charities totaled an estimated $52.16 billion in 2022. Grantmaking has increased every year since 2009 and has more than doubled from 2018 to 2022.
Key Takeaways
- Contributions to DAFs are mushrooming, increasing every year since 2009.
- Contributing to a DAF allows you to take an immediate tax deduction but wait until later to decide which charities should get your donation.
- Donations are ultimately chosen by the DAF sponsor; you have the right to advise the sponsor about the decision, but you give up control of it.
- One concern about DAFs is that the funds themselves make gains from the donations due to the fees charged to donor accounts.
What Is a Donor-Advised Fund (DAF)?
DAFs are funds set up for charitable purposes that can facilitate large donations. They are run by a third party and created to manage the donations of an individual, a family, or an organization. Though DAFS have proven quite popular, they also have received a fair amount of criticism regarding how they work and the benefits that they provide to society.
One notable feature of DAFs is the ability to invest the contributed funds. This means the amount of charitable funds can actually grow over time. This vehicle means people can have a greater overall impact of giving. DAFs are also meant to provide a streamlined, organized approach to philanthropy. The ultimate goal is to somewhat simplify things by consolidating contributions and donations into a single account, making it theoretically easier to manage the administrative side of charity.
How Do DAFs Work?
DAFs are registered 501(c)(3) organizations that are funded with cash, securities that have appreciated in value, and other assets. All of the contributions are put into an account in the donor’s name, which is held by the DAF sponsorand eventually donated to a charity of the donor’s choosing.
Donors are able to take a current tax deduction for contributions made to the fund. This is an important feature because it allows a donor to take a tax deduction for all contributions at the time they are made, even though the money may not be dispersed to a charity until much later. This incentivizes donors who need a tax deduction to make a donation now and then decide where the money will go at a later time when it’s convenient.
The ability to do this can enable many folks to give a larger amount than they would otherwise. For example, a donor with 1,000 shares of Amazon.com Inc. with a very low cost basis can hand this over to a DAF and take an immediate deduction for the full value of the donation, subject to Internal Revenue Service (IRS) limits.
If the donor wanted to do the same for a local homeless shelter, they would have to sell the stock, pay the capital gains tax on the sale, and then donate the cash.
Unlike some charities, DAFs are well equipped to convert appreciated securities or other tangible assets into cash.
Disadvantages of DAFs
Despite their relative efficiency, DAFs have come under fire because they are not legally required to spend the money they receive and can hold it for as long as they want. Furthermore, the fine print in the agreements explicitly states that donors cede all legal control of their contributions to the DAF sponsor. Although the sponsors promise that donors will retain control, the fund has the final say in what happens to the money.
There are disadvantages to using donor-advised funds. For example, the National Heritage Foundation went bankrupt in 2009 and had all of its donations seized as collateral, leaving the donors without funds to give to the charity of their choice. According to reporting by The New York Times, 9,000 funds totaling $25 million in value were wiped out.
According to reporting by PBS News Hour, another company used contributions to provide its employees with a very generous compensation plan, host a golf tournament, and pay the legal fees for a lawsuit from an irate donor. In both of the above instances, the courts upheld the sponsors’ right to use the donated funds as they saw fit.
Another complaint that has been levied at DAFs is that the funds profit from the donations they receive via the fees that they charge to donor accounts. For example, Fidelity Charitable charges the greater of $100 or 0.6% for the first $500,000 of donations to its fund. It can also make additional money off of the charges that are assessed by the mutual funds in which donors invest. DAFs often carry many hidden fees of which donors are unaware, similar to 401(k) plans.Critics, therefore, contend that the financial industry and its wealthy clients, rather than charities, are the real beneficiaries of DAFs.
$52.16 billion
The amount of money contributed to DAFs in 2022, per the National Philanthropic Trust.
Benefits of Donor-Advised Funds (DAFs)
The main benefit of a DAF is the ability to make a donation and take an immediate tax deduction for it while waiting to decide how the donation should actually be used. While the donation is irrevocable, it can grow tax-free in the DAF via investment while the decision is being contemplated.
Of course, a DAF should not be used to park money for long periods of time. Despite the critics who claim that happens too often, the National Philanthropic Trust’s 2021 Report says that DAFs have more than quadrupled the amount of money that they have paid outsince 2011, which, as noted above, was $52.16 billion in 2022.
There are also benefits to financial advisors. A study by Fidelity Charitable found that financial advisors who include charitable planning in their work can see significant advantages in their business. They had six times the median assets of advisors who don’t include it, three times the organic growth, and 1.3 times the median new money per investor.
The same study found that 76% of clients used a DAF to donate appreciated assets, 68% used it to give them time to decide where to give, and 62% used it to sustain their giving through retirement. Ultimately, a DAF is meant to and often is used to provide flexibility and growth opportunity.
What Is a Donor-Advised Fund (DAF)?
A donor-advised fund (DAF) is a third-party entity set up to manage the charitable donations of individuals, families, and/or organizations. The donor gives the money to the fund rather than giving directly to a charity. The money is subsequently doled out to charity by the DAF.
What Is the Prime Advantage of a DAF?
Contributing to a DAF allows the charitable donor to take an immediate tax deduction without deciding what charity will receive the benefits. The funds remain in the DAF until the donor decides how they want them used, which can be months or even years.
What Is the Prime Disadvantage of a DAF?
The DAF is more in control than the donor. The decision on how to use the funds is ultimately the DAF’s, not the donor’s (though the donor may advise on the matter and their advice is usually followed). Also, DAFs often come with a variety of hidden fees, some of them quite high, which leads to the suspicion that they actually benefit the DAF more than they do the donor.
The Bottom Line
DAFs can provide donors with an immediate tax deduction for funds that may not actually be distributed to a charity until months or years later. While this time lag has been a source of criticism, the use of DAFs has exploded in recent years among high-net-worth households in America. Financial advisors need to understand how these funds work and know when they are appropriate to use with their clients in order to serve them effectively.
