According to a recent Fidelity Investments report, a relatively low percentage (36%) of donors understand the fundamental principles of donor advised funds (“DAFs”). That’s an astounding statistic given the accelerated rate at which donor advised funds have grown in terms of contributions made and grants paid.
DAFs accounted for 4.4% of charitable giving in 2010. By 2017, that figure had more than doubled, rising to 10.2% of total charitable giving. As more donors become aware of and adopt DAFs as a means of philanthropic giving, these vehicles stand to become even more prevalent and their broader adoption could have a substantial impact on the practices of donors and nonprofits alike.
The blueprint of the donor advised fund was created in 1931 by the New York Community Trust in order to manage the charitable gifting of a philanthropist with a broad range of interests and substantial assets earmarked for donation. It wasn’t until the Tax Reform Act of 1969 that the mechanism behind DAFs – a transfer of assets to a charitable fund by a donor who can advise, but not directly control, the disposition of assets - was codified into law. Further legal definition of DAFs would come in with the Pension Protection Act of 2006, which:
- Defined DAFs as “a fund or account which is separately identified by reference to contributions of the donor or donors” “is owned and controlled by a sponsoring organization” and “where the donor…has, or reasonably expects to have advisory privileges with respect to the distribution or investments of the assets.”
- Excludes from the DAF classification any fund that “makes distributions only to a single identified organization or government entity” or makes grants “for travel, study or similar purposes,” with some exceptions when a grant for these purposes is made by an independent committee appointed by the sponsoring organization and the grant is awarded on an objective and non-discriminatory basis.
- Imposes penalties for certain types of distributions, along with reporting requirements for sponsoring organizations, including disclosures of the value of assets owned by DAFs, the number of DAFs and the contributions DAFs make over the course of the year.
- Directed the Treasury to review the “organization and operation of donor advised funds,” including whether gifts to DAFs should be recognized as charitable deductions, if DAFs should be subject to distribution requirements and whether the assets of DAFs are treated as completed gifts - the 2011 report recommending no legislative changes.
With the fundamentals of a DAF in mind, it’s worth considering what has led to this vehicle’s growth in popularity and spurred $29.23 billion in contributions to DAFs in 2017.
Some benefits of DAFs to philanthropists include:
- Flexibility concerning the timing of grants
- Limited recordkeeping obligations
- Option of anonymity in giving
- Support and advice from fund sponsor
- Immediate tax deduction for future gifts
- Accrual of interest on gifted assets
- Donations accepted in the form of cash, cryptocurrency, stocks, real estate and private business holdings
- Cash donations are eligible for tax deductions of up to 60% of the donor’s adjusted gross income
- Long-term assets, including stocks and bonds, aren’t subject to capital gains tax and allow an income tax deduction of up to 30% of adjusted gross income
The response to the growing prominence of DAFs hasn’t been entirely positive. Some critics have voiced concerns centering on uncertainties surrounding the vehicle’s potential impact on established practices within the nonprofit field. Critics of DAFs suggest that they encourage donors and fund administrators to sit on contributions in the hope that their non-cash assets will increase in value. Furthermore, unscrupulous fund managers could be tempted to leave contributions untouched in order to stockpile funds, inflating the value of the funds they manage rather than distributing those funds as intended. Finally, due to miscommunication or a lack of understanding of the rules governing DAFs, some donors and nonprofit employees have reported that the use of DAFs has led to conflict. By using DAFs, donors are unable to qualify for a variety of quid pro quo benefits, perks and premiums that charities may offer in exchange for high-value contributions.
Some potential drawbacks of DAFs are:
- Donors can advise but not control funds; that privilege is left to the sponsoring organization
- Donors are barred from 1) receiving any personal benefit (including any quid pro quo) from DAFs or 2) using a DAF to fulfill a personal pledge (thereby preventing charities from using pledges to underwrite expensive projects)
- Potential for conflicts of interest and lack of service on the part of financial advisors selling DAFs
With the pros and cons of DAFs in mind, the statistics surrounding their use tell a compelling story of donors’ increasing reliance on DAFs to manage their philanthropy. Grants paid out to charities by DAFs rose nearly 20% from 2016-2017, had a total value of $19.08 billion and the aggregate pay-out rate for 2013 – 2017 was above 20%. Contributions to donor advised funds grew by 16.5% from 2016 to 2017. In 2016, donor advised funds managed $86.45 billion. The value of assets in DAFs swelled to more than $110 billion by 2017, representing a 27.3% increase. There has been a corresponding increase in competition in the DAF market, with the number of funds available rising by more than 60%. The total of DAF funds in 2016, 289,478, is dwarfed by the number of funds available in 2017 – 463,622. Interestingly, many new individual DAFs are valued at under $5,000, bringing the average value of DAFs down 20.5%, from $298,628 in 2016 to $237,280 in 2017. All of these factors signal that DAFs represent an appealing option for donors at any stage of their philanthropic journey.
The take away message for nonprofits should be clear. Donors like DAF. Make sure that your supporters are aware that your nonprofit accepts DAF donations. If you have any questions about accepting DAF grants or other trends shaping the nonprofit industry, contact your Friedman relationship partner.