Donor-Advised Funds: Flexible Philanthropy or Savings Stockpile?
Many herald DAFs as a mechanism for increasing charitable giving overall. Donors can make an irrevocable donation to a DAF, take an immediate tax deduction for that year and choose where to send that money at a later point. In the meantime, the money can be invested and grow tax-free, increasing the stockpile of money designated for charitable purposes overall. DAFs also offer donors the key advantage of being able to donate illiquid assets (for example, stocks or real estate) while avoiding taxes on capital gains. This flexibility makes engaging in charitable giving a more appealing and easier process for donors.
Supporters of these funds have also argued that DAFs democratize philanthropy by offering a low-cost alternative to private foundations. A donor can set up a DAF with as little as a $5,000 donation. Over time, that initial donation can grow and make a greater impact once it is eventually allocated. In contrast, private foundations require larger overhead and maintenance costs that make them more costly than a DAF and therefore less accessible.
However, not everyone views DAFs as a positive growing trend for philanthropic giving. A key issue for critics is that there are no time limits on payout rates for DAFs. Private foundations are required to dole out 5 percent of their investment assets each year. DAFs have no such requirements. In theory, a donation can stay in a DAF over the course of many generations or even forever without being paid out to active charities. There are concerns that DAFs could thus present a substantial cost to society and to the nonprofit sector. Charitable giving in the U.S. has remained remarkably constant over the years at about 2 percent of GDP, while the number of DAFs has increased by 34 percent over the last seven years. This fact, coupled with low and possibly exaggerated DAF payout rates (see this article), suggests that money that would have otherwise gone directly to charities is locked up in DAFs each year.
Critics of DAFs approach this issue from an ethical perspective, pointing out that the management of DAFs is a for-profit industry. DAFs require management and investment fees, meaning at least some of the money lost in government tax revenue is going into the pockets of DAF managers instead of directly to the public good. It has been estimated that for every $1 million that goes into a DAF, it costs the U.S. Treasury between $300,000 and $400,000 in lost tax revenue (see this article). Furthermore, some critics argue that DAF managers tend to invest DAF money in their own mutual funds. For these reasons, DAF managers have little incentive to encourage donors to make donations to active nonprofits, raising clear ethical concerns about whether the public good has been served.
These concerns have led many to call for stricter regulations that would place time limits on DAF payouts (see this article). Supporters of such regulation have argued that high and timely payouts from DAFs are beneficial to society; enforcing a reasonable timeline would not detract from the flexibility and appeal of DAFs and would ensure tax-deductible donations actually reach the community. However, many staunchly oppose regulation, arguing that increased monitoring would raise overhead costs, thus reducing the value of the charitable gift. These opponents also argue that mandating timelines would stunt the growth of large stockpiles of philanthropic funds, decreasing donors’ potential for high-impact giving through large sums in the future (see this article).
Regardless of which side of the debate you’re on, it is important to recognize that DAFs represent a key opportunity for philanthropic advisors and consultancies to guide effective giving. If DAFs are going to increase the stockpile of funds available for philanthropy at the expense of government tax revenue, we should make sure that the grants coming out of these funds are making a measurable impact for the public good.