The Growth of Side-Car DAF AccountsSubmitted by American Endowment Foundation on June 10th, 2019
By Ken Nopar
In recent months and years, there have been many articles about the rapid growth of donor advised funds, or DAFs, in both the mainstream press and publications for professional advisors. Especially since the passage of the new tax law at the end of 2017, advisors have encouraged their clients to “bunch” their charitable donations into DAF accounts.
Ten years ago, the ratio of DAFs to private foundations was 2:1. The ratio in 2018 grew to 8:1, as the number of DAF accounts exceeds 450,000. Some donors with private foundations have closed them and opened DAFs instead, others have established DAFs to complement their private foundations and others are now evaluating whether one of these options makes sense.
Exponent Philanthropy’s 2018 Foundation Operations and Management Report determined that 17 percent of its members with private foundations already have established these “side-car” DAF accounts.
Reason for Conversion
The primary reason behind the large number of conversions is that donors can achieve their charitable goals with a DAF as well as or better than with a private foundation and at a substantially reduced cost, with less complexity and burden of responsibility. Previously, only private foundations could use their financial advisors to manage the assets, but some DAF sponsors now allow outside financial advisors to manage the assets in their clients’ donor advised fund accounts, albeit at various amounts.
A Simpler Solution
There are still a number of reasons why some donors should have a private foundation, including complete control over grants and investments, paid employment of family members or staff, and reimbursement of expenses, but the trend towards DAFs is only accelerating. With recent stories that donors donated hundreds of millions and even over $1 billion to create DAF accounts, the old thinking that donors should create private foundations if funded with $1 million is no longer current. Though the amount to be donated is only one item to be considered, most financial advisors, CPAs and attorneys agree that donors should be prepared to donate at least $5, $10, $20 or even $50 million before they should consider a private foundation, and even then, a donor advised fund is often the better solution for many donors who want a much simpler option.
DAF Accounts Can Complement Private Foundations
However, many donors with private foundations still wish to keep them for now and are opening DAF accounts that complement their private foundations for the following reasons:
- Anonymity: Donors are able to make grants anonymously from their DAF accounts, while grants from private foundations can be identified. 23% of the Exponent Philanthropy members with private foundations stated that this was one of the reasons for establishing a DAF. Though about 90% of grants from DAFs aren’t anonymous, some donors prefer to give anonymously to organizations that are outside the stated mission of their private foundation so they’re not solicited for grants from similar charities. Some donors also don’t want other board members, volunteers or even friends or colleagues to know of the amounts or recipients of some of their grants.
- Tax advantages: Donors receive greater tax benefits and can have a greater impact by donating certain assets to a DAF instead of to their private foundation. If the donor contributes appreciated illiquid assets, such as closely held C or S corporation stock, real estate, limited liability company or limited partnership interests to a DAF, the tax deduction is valued at the fair market value. If donated to a private foundation, the donor can only claim the cost basis as the deduction. Furthermore, the donor can now receive a deduction up to 60% of adjusted gross income to a DAF starting in 2018 versus only 30% to a private foundation for donations of cash and 30% to a DAF versus 20% to a private foundation for donations of appreciated assets. Once foundation donors hit these limits of donating to their foundation, some donate additional amounts to their DAF accounts.
- Giving outside of mission or location: As the number of people involved with a private foundation increases and the family members disperse geographically, there’s more interest in increasing the number of causes and charities to which the private foundation can make grants. Hopefully, the family can remain united and agree to make grants together to honor the legacy of parents or grandparents, but some private foundations establish separate DAF accounts so the family members can make grants in their own cities and to charities that fall outside of the mission of the private foundation.
- Experience a DAF before closing private foundation: Some families who are considering closing their private foundation and using a DAF instead first make a grant from the former to create the latter. Many donors are aware of the DAF advantages (that is, online grant making, ability to view past grants online, no tax filing requirements, no taxes paid on investment income, DAF sponsor responsible for vetting grantees), but want to try it first before entirely closing the private foundation.
- No mandatory distribution: Many donors with private foundations open donor advised fund accounts with a grant from their private foundation so they can fulfill the 5% mandatory annual private foundation distribution requirement. This happens occasionally at year-end when donors aren’t yet ready to make grants. Smaller or “shell” accounts at DAF sponsors can be established and ready should the need arise to make these year-end grants from the foundation. 42% of the private foundations who have DAFs in the Exponent Philanthropy study indicated that this is one of the reasons they created a DAF account. Some donors also establish DAFs because they want to accumulate enough assets to make a large grant down the line, and there’s no tax on the investments in the DAF accounts once donated.
- Succession planning: Before appointing children to the private foundation board or paying them to manage the private foundation, some parents create smaller DAF accounts and let their children gain experience with the donor advised funds to first prove that they’re capable of running the foundation or of becoming thoughtful and responsible foundation board members.
- International grants: The complexity and responsibility of making direct grants internationally is significant, so some private foundations open a DAF account and make these grants through them.
The Best Solution
Unless something unforeseen occurs, the number of donor advised funds, as well as assets donated to them, will continue to increase substantially in upcoming years. Using private foundations and DAFs together may be most appropriate, or using one or the other may be best for other donors. This is an excellent time for donors to meet with their advisors to determine the best solution for them.
(This article originally appeared in Wealth Management, April 6, 2018)
At American Endowment Foundation, we look forward to helping donors and advisors determine the best strategies for their charitable giving. Please contact us or call at 1-888-966-8170 with any questions.