The Ultimate Guide to Donor-Advised Funds
While foundations typically make up the primary funding source for nonprofits, disruption is happening with individual donors. Perhaps you've seen it already in your nonprofit. The reality is that while philanthropy continues to increase in whole dollars contributed, the number of donors declines. Paying attention to the decrease in the number of donors relative to the amount of funds you raise is vital for your organization's well-being.
So, why is this happening? One of the reasons is the ubiquity of donor-advised funds (DAFs) getting set up by donors for as little as $50. The number of donor-advised fund accounts in the U.S. surpassed 1 million in 2020, and grants to charities from the 10 largest donor-advised fund sponsors totaled $22.41 billion. These funds were once the purview of wealthy donors, but that's no longer the case. Now, many donors, including general gift contributors, can set up one. As a result, what's happening is that a wedge is being created between fundraising officers and donors. And, candidly, this is something that donors want.
While American philanthropy continues to be the global leader, and we're a very generous people, this may be a situation where nonprofit fundraising worked a little too well. In other words, people have gotten inundated with requests (even low-level donors). However, all's not lost for nonprofit fundraisers. For instance, technology is shifting the paradigm of fundraising to a subscription-based model using artificial intelligence and machine learning.
With donor-advised funds, fundraisers must be aware of what they are and what's happening to create new opportunities for themselves. We know for sure in philanthropy that inevitably, things change. It may seem slower than what happens in the corporate world, but the reality is that the days of slow change are now in the past. Tech and disruption are ongoing aspects of life, including in the nonprofit sector. So, let's dive into how donor-advised funds can help you with your overall fundraising strategy.
What’s a Donor-Advised Fund?
A donor-advised fund is a type of restricted fund designed to provide donors with a way to make charitable gifts to qualified nonprofit organizations. Initially, donors loved the idea of donor-advised funds because they wanted to contribute meaningfully but didn't want the complication or costs of setting up a private foundation. Therefore, donor-advised funds by sponsoring organizations, such as National Christian Foundation, Schwab, Fidelity, National Philanthropic Trust, etc., provide a genuine service to donors.
The donor-advised fund sponsoring organizations (e.g., Fidelity Charitable Trust) take on the work of making necessary regulatory filings required of foundations. They also handle the expense of these activities with their army of lawyers and financial advisers. So, what is in it for them? The answer is straightforward. In exchange, they manage assets and provide a revenue source to the donor-advised fund in doing so.
Why are donor-advised funds so popular? For starters, they provide a tax-deduction upfront for donors. This means that donors get the tax write-off in the tax year they contribute. But donors can wait years before choosing a nonprofit to support with their contributed assets. Many people prefer the idea of building assets until they give away more substantial gifts in the future. However, we have a significant threat to nonprofits because releasing funds to nonprofits might not ever happen.
The Threat to Nonprofits With Funds Parked for Years
Donor-advised funds are an ever-growing way to support nonprofits. Specifically, in theory, donors can put money toward philanthropic causes while also getting a little something back in a charitable tax deduction. Sounds great, right? Well, a few downsides exist that aren’t so great for nonprofit causes.
Donor-advised funds are not a charity in the traditional sense. Sure, they’re designated as a 501(c)(3) by the IRS, and this is how donors get their tax write-off. However, they don’t normally deliver programs or do things in the community. Instead, they are more of a depository for the favorite organization of donors.
You see, the money donors deposit into donor-advised funds comes with strings attached. For instance, donor-advised fund money managers don't have much incentive to encourage donors to designate a nonprofit for a contribution. For them, they don't mind that the money sits parked in donor-advised funds, making more money. And that's why more than $140 billion sits parked in these funds.
Also, with the lack of incentive for donor-advised funds to release the funds and donors having a middle person between them and the nonprofit cause, there's a growing distance between givers and organizations. Of course, that can't be good for nonprofits, especially at a time of growing space by donors away from nonprofits.
Another challenge for nonprofits that many people don't know is that the donor-advised fund often gets the money in full in the event of death. In other words, unless there is a succession agreement between the donor and the DAF, the funds transfer to the donor-advised fund at the time of death. Without an agreement, the donor-advised fund will gain control of the assets and can do as it wishes for whatever charitable endeavor it chooses.
And finally, there's another significant challenge for nonprofits with donor-advised funds. You see, it's the sponsoring organization that gets the final say on where the money gets transferred if a donor requests a gift. Remember, the donor moved the capital to a donor-advised fund, so they own the money. Meaning that if there comes a time when a sponsoring organization thinks they don't want money going to a particular cause, they get the final say — not the original donor. A recent example is a donor-advised fund prohibiting gifts to the NRA.
Why Are Donors Choosing Donor-Advised Funds?
One big draw to donating to a donor-advised fund is that donors seem to get more control over their philanthropic giving. The reality is that donor-advised fund sponsoring organizations have done an excellent job at marketing their products. It’s something akin to the bill of goods generations have been sold about the scarcity and preciousness of diamonds.
Donors are told they could park their funds and work with expert money managers to grow their philanthropic giving. That's a very attractive offer to donors. Again, many Americans are very philanthropic, and people tend to want to make the most significant impact they can make, which is the American way — go big or go home.
Further, there’s truth to the reporting that donor fatigue exists. Donors are tired of the relentless requests for money. Many nonprofits don’t demonstrate impact well, and so many donors believe that nothing ever really changes, which isn’t true. And with technology creating distance and greater control between donors and their favorite causes, it’s no wonder donor-advised funds have dropped their entry-level ever lower to create a fund.
A donor crisis severely challenges the nonprofit sector. It's not a crisis as much as it's a fact for which every nonprofit needs to prepare. In the past few years, the number of Americans that give directly to nonprofit organizations declined. Many experts attribute this to the rise of nonprofit fundraising platforms, like Kickstarter and GoFundMe, making it easier than ever to ask friends, family and even strangers for money.
Other experts believe that the decline is because many Americans have become disillusioned by the lack of results from nonprofits (i.e., demonstrating impact). They feel their money goes to waste, and they get asked repeatedly to dole it out to organizations with no incentive to work harder and produce high-quality results. Either way, the fact remains that the nonprofit sector needs donors. Fortunately, nonprofits can take plenty of steps to increase their donor base.
How to Work Around Donor-Advised Funds
All’s not lost for nonprofits. But, it's going to take marketing and positioning of the cause and investment in technology that better targets donors. For starters, nonprofit fundraisers need to analyze their donor databases and ascertain if they've had a drop in donors — even if the fundraising revenue increased year-over-year. That could give you the first clue that you may have a more significant challenge down the line.
Then, it’s vital to survey donors. You can’t make adjustments if you don't know what your donors think and value. So, it's a good idea to survey all your donors and ask them how you're doing. And it's also ideal to add a few questions about how donors want to give and if they have a donor-advised fund or plan to get one in the coming year. That's essential to providing you an idea of who in your database is likely to ghost you as they get more involved in distancing themselves behind a wall of a donor-advised fund.
A strategic approach to overcoming the donor-advised fund challenge is to make friends. So, if you happen to have a donor-advised fund sponsoring organization in your town, make it a point to connect with them in person. Develop a relationship. Then, when you have a solid relationship, invite donors to sessions you co-brand where you discuss the benefits of donor-advised funds. What does it accomplish? It helps you gain some control over the donor-relationship and know where the donor-advised funds exist. In other words, you become a conduit to what donors want.
Also, another strategic tactic you should get in the habit of doing is to develop relationships with planned gift experts and attorneys. Remember, if a donor doesn't precisely specify what happens to the donor-advised fund gift with a succession agreement, the money gets transferred to the sponsoring donor-advised organization. Therefore, it's vital to get ahead of it. And providing sessions and seminars on donor-advised funds and planned giving is crucial for you to maintain your nonprofit in the relationship with both the donor and the donor-advised fund sponsoring organization.
Tactical Steps to Develop Critical Relationships to Avoid Donor Attrition
Again, the chances are that your nonprofit is experiencing a decline in donors, even if your fundraising revenue is high. So, you want to get ahead of donor attrition because it costs more to get a new donor than to keep the ones you already have with you. That means you have to promote opportunities they want — from crypto giving to donor-advised funds. The following are tactical steps for marketing and relationship management.
- Spread the word. Tell your donors about the donor-advised fund and how they can contribute. Remember, you want to be part of the relationship. So, serve as the essential conduit to donors if that's what they want. And don't forget to do regular donor-advised fund and planned giving seminars and webinars.
- Keep the fund manager in mind. Build relationships with the donor-advised fund manager and promote those to your donors who want to work with you and show it. If you find that a sponsoring organization gives you a bit of a cold shoulder, move on to the following organization. Then, promote to donors the one that works with you.
- Keep an eye on legislation. As we know, the U.S. debt keeps on increasing. And that means that the federal government will look for ways to raise taxes and revenue. One of the ways is going to be through donor-advised funds. Talk for legislation is already moving to open the spigot of parked money in donor-advised funds.
- Understand your finances. Track your finances carefully. Again, even if you seem to go past your fundraising goal annually, it doesn’t mean the financial health of your nonprofit is good. You have to keep an eye on donor attrition because most donors do, in fact, move on from your organization after several years.
- Be prepared and lean into technology. Plan for the future of fundraising now because it's already here. That means you have to rely upon technology — even if you're a part of a small nonprofit. Look for capacity-building grants or ask a major donor to invest in technology that will help you raise funds more precisely.
We know that most nonprofits in the United States are small. However, that doesn't mean they can't grow to scale. Every large nonprofit of today was once small. Further, nonprofit leaders who want to stay ahead of the changes in philanthropy, including what's happening with donors and donor-advised funds, must take it upon themselves to learn the lay of the land and take action.
This guide should serve as a primer to the essential realities of donor-advised funds, donors and your nonprofit organization. But, know this; with strategic efforts, leaning into technology and giving donors something visionary to get excited about, your nonprofit can overcome any challenge. Moreover, concerning donor-advised funds, you can get around the walls they could create. So, the rest of it is up to you.
Paul D’Alessandro, J.D., CFRE, is the author of "The Future of Fundraising: How Philanthropy’s Future is Here with Donors Dictating the Terms." He’s the founder and chairman of High Impact Nonprofit Advisors (HNA), and also D'Alessandro Inc. (DAI), which is a fundraising and strategic management consulting company with more than 30 years of experience in the philanthropic sector.
He has worked with hundreds of nonprofits to raise over a billion dollars for his clients in the U.S. and abroad. In addition, as a nonprofit and business expert — who is also a practicing attorney — Paul has worked with high-level global philanthropists, vetting and negotiating their strategic gifts to charitable causes. Paul understands that today's environment requires innovation and fresh thinking, which is why he launched HNA to train and coach leaders who want to make a difference in the world.