Though the popularity of donor-advised funds (DAFs) continues to expand, many attorneys, accountants, and financial advisors continue to report clients initially wanting to create private foundations (PFs). However, after a short conversation, far more donors decided to establish DAF accounts instead – according to Philanthropy Roundtable, DAFs outnumber PFs five to one (or more) and are growing at a faster rate.

There are some donors who do (and should) end up creating PFs, but these numbers indicate that fewer PFs are created today while DAFs have become the dominant charitable vehicle. Additionally, in terms of actual dollars going to charitable causes, DAFs consistently pay out grants at a rate of about 24% – not including administrative expenses, as noted by the National Philanthropic Trust.

There may be a compelling reason for financial advisors to suggest a private foundation, especially for clients who intend to fund it with a large sum of money (often between $10 to $50 million). But DAFs seem to be the go-to suggestion as they offer more flexibility for a greater number of clients. Comparing DAFs and PFs can help donors decide which is the best option for their charitable goals.

Benefits of All Charitable Vehicles

Whether a donor chooses a DAF or PF, the most important goal is funding worthy causes.

With that in mind, the following are key benefits of both DAFs and PFs as charitable vehicles:

  • Donors can receive a tax deduction the year they donate assets.
  • A person can fund the charitable vehicle following a liquidity event, large income year, or retirement payment, then the DAF or PF can continue to make grants in subsequent years – even when the donor’s income is lower.
  • DAFs and PFs allow for granting to charities over time rather than making one large donation.
  • DAFs and PFs are more likely than other charities to accept donations other than cash, such as stock or complex assets.
  • DAFs and PFs can help teach philanthropy to children and heirs, allowing for family involvement over time.
  • Future generations can continue working with the charitable vehicle.
  • Charitable vehicles make it easier to track donations and grants.

Benefits of Private Foundations

Some donors feel more comfortable opening private foundations for reasons such as:

  • The donor can maintain control over the PF’s grants and grant recipients, whereas through DAFs they are recommended (though most DAF sponsors work with the donor or financial advisor to approve grant recommendations).
  • They are drawn to the perceived status of having a private foundation and are not concerned with cost, complexity, or IRS oversight.
  • PFs can grant to individuals in cases of hardship if the situations meet IRS criteria.
  • PFs might allow more control over investment options (though many DAF sponsors allow outside financial advisors to manage assets at a certain level).

Benefits of Donor-Advised Funds

Donors are opening DAFs more often because of the wealth of benefits they offer, including:

  • DAFs typically have minimal annual fees, while PFs are expensive to create and maintain.
  • DAFs can be established much faster, possibly in days or weeks, while PFs can take months.
  • Most donors receive significantly higher tax deductions when donating assets to a DAF.
  • When donating complex assets to a DAF, donors are generally entitled to a tax deduction for the fair market value, instead of the original cost basis applicable to a PF.
  • There are no required annual tax filings for DAFs, while PFs must file complex IRS forms and state filings annually.
  • There is generally no tax on investment income in DAFs, whereas PFs are subject to an excise tax of 1.39%.
  • Donors can decide to donate anonymously through DAFs if they want, while all PF grants are public information.
  • DAF sponsors handle all grant administration, while PFs are responsible for their own.
  • DAFs are generally easy and efficient for donors.
  • Online grants and account history are more common with DAFs.
  • DAF sponsors handle issues of legal compliance, relieving donors of this burden; PFs are subject to IRS scrutiny and must keep official meeting notes, justify salaries paid to family members, carry insurance for board members, ask trustees to sign conflict-of-interest statements, and more.

Conversion to DAFs & Complementary DAFs

As awareness of DAFs rapidly increases, many donors are considering converting their private foundations to DAFs. Even those who don’t want to close their PF completely might see the benefits of establishing a complementary DAF. As Philanthropy Roundtable also notes, while grants to DAFs only represented about 3% of PF grantmaking in 2021, that number is a staggering $2.6 billion and rising. PFs can also use DAFs to:

  • Pool resources from more donors
  • Engage their donors directly in the grantmaking process
  • Save on administrative costs
  • Respond quickly to emerging philanthropic needs

More donors are realizing, often with the help of their financial advisors, that they can accomplish their charitable goals through a DAF for a lower cost while reducing the burden, responsibility, complexity and other issues of operating private foundations.

Discussing Charitable Goals

For financial advisors, there are many benefits of having charitable planning conversations with clients. They can help determine a client’s desire for simplicity vs. tolerance for complexity to help determine if a DAF or PF is better for them. Other helpful information that comes up in these conversations includes:

  • The timeframe for giving
  • Who will be involved in their philanthropic efforts
  • How much they want to invest in a structure for giving
  • Why they want or need a charitable vehicle

Financial advisors should discuss what has worked well for their clients in the past and what has been a cause of frustration or concern. Clients who need absolute control and don’t mind the regulations, requirements, responsibilities, and costs might prefer a private foundation. However, donors who want to make simple, efficient grants to their favorite charities, receive higher tax benefits in some cases, and save on administrative costs will likely prefer a DAF.

Talk to AEF to Learn More About Opening a DAF

American Endowment Foundation (AEF) is always excited to talk to donors about the benefits of our DAF accounts. We can provide resources to compare AEF DAFs vs. private foundations to see what will work better for you. If you’d like to start the conversation, contact us today. We’ll work with you to expand philanthropy in the best way for your unique situation.

NOTE: An earlier version of this article was published at WealthManagement.com.