Bah Humbug and The Darker Side of Donor Advised Funds

Bah Humbug and The Darker Side of Donor Advised Funds

Donor Advised Funds (DAFs) is a very hot topic in the news these days:

  • Donor Advised Funds – Gaining Assets and Fans (The Wall Street Journal, November 14, 2017)

  • What are Donor Advised Funds? (The Wall Street Journal, December 3, 2017)

  • Why Tax Reform Makes This The Best Time To Open a Donor Advised Fund (The Wall Street Journal, December 10, 2017)

  • How The Tax Bill Changes The Math on Donor Advised Funds  (The Wall Street Journal, December 20, 2017)

Everywhere you look, it’s DAFs, DAFs, and more DAFs.  In a period of less than a month, the Wall Street Journal dedicated a lot of ink to talking about this tax planning technique. It makes sense – the Donor Advised Fund is an interesting tool in the financial and tax planning toolbox. It not only creates a charitable deduction when you transfer holdings into it, but it also shelters the capital gain from recognition when you move appreciated securities. 

And the Journal isn’t the only publication promoting the DAF.  You can find a plethora of articles from the Washington Post to the New York Times to Money Magazine.  DAFs are the new black in tax planning.

For more than 15 years, I have used DAFs as a powerful tax planning technique. I’ve written and been quoted about their benefits, advised clients on how to use them, and even have one of my own. But with all the buzz about what a great technique they are for year-end 2017, I began to look at the phenomenon more closely.  We buy in so easily to this planning technique, but are we really looking at it in the context of the financial world? Without careful thought of the darker side of DAFs, taxpayers could be missing the mark in terms costs and benefits.

Who’s Really Getting the Benefit?

One of the key differences between a charitable foundation and a DAF is that the charitable foundation is required to give away 5% of its corpus on an annual basis, which the DAF has no such requirement. Sometimes a family foundation will meet their 5% requirement by simply moving the required amount to the family’s DAF.  This allows them to technically meet the 5% rule, but maintain control of the funds. Further, once the taxpayer funds the DAF, from the perspective of tax benefits, the donor is no longer monetarily incentivized to actually recommend a grant to a charity. The result?  Taxpayer 1; Charity 0.

This may seem relatively innocuous.  However, the National Philanthropic Trust’s 2017 Donor Advised Fund Report showed that by the end of 2016, DAFs had funds of $85.15 billion dollars, but only 20% was actually disbursed to charities in 2016.

This presents an ethical question. Would charities be better off in the absence of DAFs, relying instead on getting donations directly from taxpayers.  Receiving charitable donations sooner, without the “middleman” of a DAF, might enable non-profits to address larger issues in a more timely fashion, thereby having a greater impact on goals such as fighting disease, helping people who are struggling, and improving the lives of many.

In the summer of 2014, the hottest trend sweeping the nation was the ALS Water Bucket Challenge.  It was a unique – and very odd – way to raise funds and awareness for a charity. Amazingly, it worked.  The Challenge raised over $115 million for ALS, and was split between research (67%) and funding patient and community services (20%). 

In the three years since the challenge, the inflow of funds has had an impact on this devastating disease.  The investment in research resulted in the discovery of a variant of a gene called NEK1 which is linked to 3% of ALS cases, providing a new target for drug development. Scientists in St. Louis, Boston and Los Angeles have received grants to focus on biomarkers for the disease. The donations toward patient care resulted in grants for speech therapy, training for caregivers, as well as ramps and stair lifts.  Charitable intent has made a difference.

If the donations had not gone directly to the charity and been put to work immediately, would this level of progress have been made? Would more frequent grants from DAFs help charitable organizations more quickly move their particular needle forward?

Is Wall Street Laughing All The Way to the Bank?

The other dark side of the DAF is the fees involved.  Of course the financial organizations that offer DAFs do provide needed administration, including compliance and tax filings. They work with the donors to help fund, answer questions and review recommended grants.  But DAFs have two fees – the investment fees and the administration fees – a sizeable amount going into the coffers of the investment world.

Administration fees for DAFs are typically based on the size of the account.  The larger the account, the lower the fee percentage.  However, most DAFs start between 0.60% and 1.25%.  (Note: Philanthropy.com has a great fee comparison chart at https://www.philanthropy.com/article/What-Donor-Advised-Funds/156495.) The National Philanthropic Trust estimates that in 2016, the average Donor Advised Fund balance was $298,809. Do the math and you realize DAFs are great money-makers for the administrators. In 2016, the top 3 donor advised fund providers were Fidelity Charitable, The National Christian Foundation and Schwab Charitable. [1]

Charities are often criticized for administration costs – and rightly so.  But there should be greater scrutiny of DAF administrative costs. Typically providers of DAFs are brokerage firms and banks – and they should be held accountable.

To DAF or Not To DAF...

Despite these two ‘dark’ issues of DAFs, I asked myself whether, given all I now know, I would still fund a Donor Advised Fund. My answer is yes. I do believe that DAFs are potentially great tools for donors and for charities.  They help move money to charities and allow regular people to create charitable legacies.

But one thing I will do differently is to be proactive in actually making grants from my DAF, rather than letting the funds just languish. I encourage all DAF owners to think beyond their tax deduction, and consider the good those funds can do when used by the charities that depend on them. After all, isn’t that the kind of legacy that drove the decision in the first place.

 

[1] The National Philanthropic Trust’s 2017 Donor Advised Fund Report can be found here: https://www.nptrust.org/daf-report/

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