Rise of the Donor-Advised Fund: A Fast-Growing Vehicle to Charitable Giving
In our sector, we are constantly faced with obstacles of how we can increase charitable giving; but more particularly, how can we get our donors to continue to give over the years. A donor-advised fund is an account sponsored by a nonprofit organization that enables donors to give to charities and receive tax benefits—essentially a charitable savings account. Sponsoring organizations can be a national charitable institution, such as Fidelity Charitable or Vanguard Charitable, or community foundations, which are grant-making public charities dedicated to improving communities in a defined local geographic area.
“National donor-advised programs give donors a different kind of flexibility than they might otherwise not have with community foundations. There are about 700 of them, so it’s hard to say that they all act the same way, because they don’t,” Eileen R. Heisman, president and CEO of National Philanthropic Trust, told us in an interview. “Before picking a sponsoring charity, I always suggest [the donor] look to see if the organization has a program focus. The sponsor has to be compatible to its donor. Donors should also look at fees, investments and the number of generations advised.”
According to the National Philanthropic Trust, here’s how a donor-advised fund works:
• A donor makes an irrevocable contribution of personal assets.
• That donor will immediately receive the maximum tax deduction that the IRS allows.
• That donor then names the donor-advised fund account, along with any advisors, successors or charitable beneficiaries.
• Their contribution is placed into a donor-advised fund account, where it can be invested and grown tax-free.
• At any time afterward, that donor can recommend grants from their account to qualified charities.
Once a donor invests an asset—whether it’s cash, cash equivalents, non-cash assets or non-publicly traded assets—they can make grant recommendations on where they want the funds to go and decide if they want to spend their donor-advised fund, continue to add to the account each year or pass it down to their children.
Fred Kaynor, vice president of business development and marketing at Schwab Charitable, says donor-advised funds work like a three-step equation—contribute, invest and grant.
“[Donors] contribute the assets. They invest them once the assets are liquidated and the fair-market value proceeds are deposited. [The donor] then balances those assets and funds among 14 different investment pools that we offer for growth while they’re in the account. The third part is that they grant them, meaning once they balance and invest these assets for growth, they grant the resources out to the charities that they choose to support,” he said.
Benefits of Donor-Advised Funds
“Fidelity Charitable’s 2016 Giving Report” notes that one of the major benefits of donor-advised funds is that a donor can increase the donation over time—tax-free. In the past 10 years, the number of Fidelity Giving Accounts has significantly increased from 40,000 to 80,152—that number represents over 132,000 donors. The report found that the median Giving Account balance is $15,000, 61 percent had a balance under $25,000 and 5,999 accounts have a balance of $250,000 or more.
“Fidelity is the largest entity that houses donor-advised funds. In the last 20 years to 25 years, other entities have come on board and offer donor-advised funds to people of all income and interest levels,” Robert Evans, president of the Evans Consulting Group LLC, said. “Personally and professionally, I think donor-advised funds are a great tool; they help donors be more sophisticated and planful in their giving and help reduce costs that foundations have, which are significant.”
Donor-advised funds have seen a significant growth in the last few years. We suspect the growth is due to the fact that people want to be more philanthropic and have a strong interest in giving back to their communities, but another reason is that donor-advised funds do not cost nearly as much to invest in as a private foundation.
We spoke to Suzanne Friday, senior counsel and vice president of legal affairs at the Council on Foundations, who believes the exponential growth of donor-advised funds is attributed to
donors who do not want to put in the expense and work of establishing a private foundation.
“Generally, to set up a private foundation, you need significant assets to begin with due to the expense of setting up the foundation and the ongoing cost of supporting the foundation’s operations. Depending on your sponsoring organization, donor-advised funds can be started with much smaller amounts,” she said. “It kind of brings philanthropy to a whole new sector of donor who wouldn’t normally be candidates for a private foundation.”
In 2015, grants made from donor-advised funds totaled $14.5 billion—a 16.9 percent increase from the previous year, according to National Philanthropic Trust’s “2016 Donor-Advised Fund Report.” In the same year, total contributions to donor-advised funds reached an all-time high of $22.26 billion—an 11.4 percent increase from the previous year. The number of donor-advised fund accounts reached 269,180 in 2015, with an average of $235,727 in a donor-advised fund account—an 8.8 percent increase from 2014. Furthermore, the grant payout for 2015 was 20.7 percent—significantly higher than the standard grant payout of 5 percent for private foundations.
“There is almost 10 times the amount of assets in private foundations, but they only give away 5 percent. Donor-advised funds have one-tenth the amount of assets that private foundations do on average, and we give out 20 percent,” Heisman said.
When donors invest in a donor-advised fund, they are investing an irrevocable gift to the sponsoring organization. The assets no longer belong to them, but to the sponsoring organization. While donors have advisory privileges on the account and can recommend where the funds go, the sponsoring organization makes the final decision on where the funds go. Friday notes that when a donor opens a donor-advised fund account, “the donor earns a charitable tax deduction for that gift, which they can take on their income taxes at the time the gift is made.”
“I think the beauty of a donor-advised fund and one of the benefits is the ability to donate money and take an immediate tax deduction, which helps grow it for charity. Certainly, the ability to take that via tax-deduction is one of the main reasons why people started donor-advised funds,” Amy Pirozzolo, vice president of marketing at Fidelity Charitable, said. “Over 90 percent of our donors have told us that is the reason why they started a donor-advised fund.”
Heisman notes that unlike private foundations, if a donor opens a donor-advised fund account with a national charitable foundation, donors don’t have to worry about the tax filing because the sponsoring organization takes care of that.
“We make sure that the check has been cashed. We issue you a tax receipt. You don’t have to take minutes of meeting or hire an accountant firm to do your financials. We bundle all that in the work that we do when the donor opens up a donor-advised fund account, so you get the benefit of giving, which people really like, but you don’t have the burden of all the record-keeping, tax-filing, accounting requirements and administrative work that you have to do with a private foundation,” she said.
Challenges of Donor-Advised Funds
One of the biggest problems nonprofits face with donor-advised funds is that they do not communicate with the donor well. This varies from nonprofit to nonprofit. When a nonprofit receives a grant check from a donor-advised fund, it is listed as from the sponsoring organization, so more often than not the nonprofit is reaching out to thank the sponsoring organization when they should be thanking the donor.
Nonprofits have to be smart about thanking and acknowledging their donors for their gift from their donor-advised fund. Evans says because most campaign-management packages require tweaking to track if a donor has a donor-advised fund, nonprofits have to be more diligent in thanking donors properly.
“Even though a donor may send in a gift from a donor-advised fund, it doesn’t mean the donor-advised fund gets the acknowledgment, thank you and so on. It needs to go to the donor because it was the donor who advised the fund to make the gift. We hear horror stories all over the country where management of a gift has been improper, and the thank you goes to the wrong party,” he said.
To avoid this mistake, Pirozzolo advises nonprofits to recognize the donor, reach out and invite the donor to learn more about the organization, invite them to establish a recurring gift to the
organization and ask the donor to list the organization as a legacy upon their death.
“If I were a nonprofit, I would put them at the top of my list to reach out to,” she said. “Only about 9 percent of giving is done via bequest, but at Fidelity, 42 percent of donor-advised fund donors have set up a bequest or a legacy. Donors do have the option that upon their death, they can name a charity as being a successor on their account and many donors will.”
Along with communication challenges of donor-advised funds, there are also legal restrictions. When the Pension Protection Act (PPA) was passed in 2006, it introduced Section 4966 and 4967, which were
specific to donor-advised funds. In addition to defining what donor-advised funds are, the new sections introduced additional restrictions. According to the IRS, Section 4966 “imposes an excise tax on a sponsoring organization that maintains donor-advised funds if it makes certain distributions from a donor-advised fund” and Section 4967 “imposes excise taxes on certain distributions from a donor-advised fund that provide more than an incidental benefit to a donor, a donor advisor or related persons.”
[Under the PPA, donors with donor-advised funds] must make grants strictly for charitable purposes, and if they are making grants to an organization that is not a public charity, the sponsoring organization has to exercise what is called ‘expenditure responsibility,’ which is a series of steps to provide due diligence to make sure the grant money is being used for charitable purposes. Donor-advised funds are also subject to something called the ‘Excess Business Holdings’ rule,” Friday said. “This states that a donor-advised fund together with related parties cannot hold more than 20 percent of any one business interest.”
Increase in Donations
Nonprofits could potentially see a significant increase in donations by properly communicating and marketing donor-advised funds to donors. The sector is already seeing a substantial increase in charitable giving, according to the “2015 Giving USA Report.” America’s best year of giving was 2015, which surpassed the previous highest year of 2007.
“One of the things we’re seeing is that some high-net-worth people—not just the ordinary Mary or Joe—are recognizing the vibrancy of donor-advised funds over foundations, so that they’re creating their own donor-advised funds with very substantial dollars,” Evans, who is also on the editorial review board for Giving USA, said. “As we saw in the GivingUSA report for 2015, giving to foundations was down
primarily compensated by giving to donor-advised funds.”
Fidelity Charitable has seen a significant increase in donations since 1991. According to its report, the organization “has granted $21 billion to charities, 61 percent of all contributions since inception.” The report also found that the number of donors doubled within the past 10 years. In 2006, Fidelity’s Giving Accounts funded 53,076 nonprofits—that number doubled to 106,250 in 2015.
“Putting funds into a donor-advised fund allows the donor to be thoughtful, to do their research and to know the nonprofits before they decide to give. I would say a good chunk of folks tell us that the reason they start a donor-advised fund is that in their retirement years, they intend to do more for charity, volunteer more and want to continue giving as they have given in their working years, but they know they won’t have an income,” Pirozzolo said.
Facebook founder Mark Zuckerberg and his wife, Priscilla Chan, established their own donor-advised fund in 2014, which was reported at $175 million. Although Zuckerberg and his wife are among the wealthiest people in the world, Evans noted that more people are “creating and distributing funds more than ever before” for good reasons; one of which is a desire to make larger gifts.
Future of Donor-Advised Funds
Yes, we have seen a significant growth in donor-advised funds in the last few years, but will donor-advised funds continue to grow at its increasing pace? We suspect not. All things that grow at an increasing rate almost always have to slow down at some point. We do believe that donor-advised funds will continue to grow, but it may slow down in the next few years. What goes up must come down, right?
According to Heisman, most things don’t continue to grow in double digits, so at some point, the growth of donor-advised funds is going to trickle down. But you never know what the future holds.
“There are a lot more millennials than there are baby boomers, so it’s possible there will be another burst when millennials start to earn more money than they need to live,” she said. “I think millennials will probably be good users of donor-advised funds.”
A particular tool that could boost the growth of donor-advised funds even more is a program called “DAF Direct.” This program allows nonprofits to place a widget on their website to enable donors to initiate grant recommendations from their donor-advised fund directly to the organization’s website or online-fundraising campaign.
Here’s an example of how it works: “With one click, I [am directed] to my Fidelity account. When I log into my Fidelity account, it automatically populates the Red Cross’s tax ID, so I’m not fumbling to figure out what their ID is to make sure it’s the right organization. It’s two clicks away from accessing the money sitting in these donor-advised accounts if you put this widget on your website and on your communications,” Pirozzolo said.
We have seen the growth in Fidelity’s numbers, but there are also big numbers in Schwab’s “2016 Giving Report.” Sixty-five percent of Schwab’s donors say that they give more because of their donor-advised fund account. In 2016, grants totaled $1.2 billion—supporting over 56,000 charities.
“This is a tremendous statistic. We are seeing that we are an efficient solution for them. For tax-reporting purposes, it’s a one-stop shop. We accept a variety of different gifts that may be straightforward or complex in nature. I think that efficiency is something that they
value tremendously. It’s an efficient and effective way to holistic manage donor’s philanthropy. I think that’s really the primary reason why it’s been such a success,” Kaynor said.