This column is an updated version of our column that was originally published in WealthManagement.com   

Though there has been an explosion of new donor-advised fund (DAF) accounts that have opened in the past decade, many attorneys, accountants, and financial advisors report that some clients still come to them and state that they want to create a private foundation (PF). Once they have listened to their advisors, however, far more clients open up DAF accounts instead.

There are still some donors who should and do create PFs, but the numbers indicate that few PFs are created today and that DAFs have become the dominant charitable vehicle. The number of DAFs has increased during the past 15 years from 150,000 to 2,000,000, while the number of PFs has barely increased in the same time frame from 80,000 to 90,000.

While attorneys and advisors twenty years ago felt that clients should perhaps consider PFs if they would initially fund them with $1, 5, or 10 million, today most advisors indicate that a client should not begin to contemplate a PF unless they would fund it with at least $10, 20, or 50 million. Even at those and higher levels, many if not most advisors still recommend creating a donor-advised fund unless there are compelling reasons to create a PF.

Conversion to DAFs

As awareness of DAFs has increased rapidly among donors who already have PFs, many of them are closing and converting their PFs to DAFs or are establishing DAFs to complement their PFs. Foundation Source indicates that 88% of PFs are below $5 million and 2/3 are below $1 million, but it is quite possible that many of these were opened when PFs were popular in the 1990s and early 2000’s.

Donors increasingly realize, often with the help of their advisors, that they can accomplish their charitable goals through a DAF for significantly less cost and can reduce the burden, responsibility, and complexity of operating the PF.

Benefits of Charitable Vehicles

There are many advantages for donors to create a charitable vehicle, regardless of whether it is a DAF or PF. These include:

  1. They can donate assets to the vehicle and receive a tax deduction in the year of the donation.
  2. If donors have a liquidity event or large income in a particular year, or they are approaching retirement while continuing to earn a big paycheck, they can donate to the vehicle to receive a significant tax benefit and make grants in subsequent years when their income is less.
  3. Donors may not want to donate too much to a charity at one time so by donating to a vehicle, they can receive the large tax deduction and grant to the charity over time.
  4. Donors can continue to grant consistent amounts from their vehicle even when their income or investments drop in value in certain years.
  5. Charities are often unable to accept donations of complex assets, and it is cumbersome for some to accept even publicly traded stock. Charitable vehicles, especially DAFs, regularly accept illiquid assets.
  6. Vehicles can be used to help teach philanthropy and pass on family values to children and heirs and keep the family united for the future.
  7. Donors may want their giving to continue with future generations.
  8. Vehicles can enable donors to more easily keep track of donations and grants to and from the vehicle.

Benefits of Private Foundations

Some donors still feel more comfortable in opening foundations for some of these reasons:

  1. Grants are assured, not recommended, though most DAF sponsors approve nearly all grants.
  2. They are not concerned about costs, complexity, or IRS oversight, or may desire the perceived status of having a foundation.
  3. They can pay for expenses and hire and pay for staff including relatives, though IRS can review.
  4. PFs can grant to individuals in case of hardship if IRS criteria is met.
  5. Can allow for more control over investment options, though many DAF sponsors now allow for outside financial advisors to manage assets at certain minimum levels (American Endowment Foundation at $10K, Fidelity and Schwab at $100k, Community Foundations often at $500k or $1,000,000).

Benefits of Donor-Advised Funds

Yet far more often these days, donors decide to open DAFs instead of PFs because:

  1. There is no cost to open DAF with minimal annual fees, while PFs are expensive to create and maintain.
  2. DAFs can be opened within days or weeks while PFs can take months.
  3. Clients can receive significantly higher tax deduction for donating certain assets to DAF (i.e. Cash donation deductible up to 60% of AGI for DAFs vs. 30% for PFs, and other assets deductible up to 30% of AGI for DAFs vs. 20% for PFs).
  4. Donors are generally entitled to a tax deduction of the full fair market value of a donation to a DAF for many complex assets, instead of the original cost basis that would be applicable to a PF.
  5. There are no required annual tax filings for DAFs while PFs must file annual complicated 990PF and state filings.
  6. There is no tax on investment income in DAFs, while PFs are subject to excise tax of 1.39%
  7. DAF Donors’ anonymity is assured if desired, while all PF grants can be viewed by the public and other charities.
  8. DAF sponsors handle all grant administration, while PFs must be responsible for their own.
  9. Donors want the simplicity that DAF sponsors provide as they are easy and efficient to use.
  10. Many DAFs offer online granting and viewing of past grants and donations, while many PFs do not or donors must pay for this ability.
  11. DAF sponsors are responsible for complying with the laws, thus relieving donors of this burden. PFs must keep official meeting notes, provide compensation benchmarking backup to IRS to justify salaries paid to family members, carry various types of insurance for board members, ask trustees to sign conflict-of-interest statements, etc.
  12. There are no minimum annual distributions for DAFs, compared to 5% minimum for PFs.

Discuss Charitable Goals

Clients are best served when their advisors discuss their charitable goals. They can help determine their clients’ desire for simplicity or tolerance of complexity, the time frame for giving, who will be involved, how much clients want to invest in a structure for their giving, and why they want or need a charitable vehicle.

Advisors should discuss what has worked well for their clients in the past and what has been a cause of frustration or concern. For clients who need absolute control and don’t mind all of the regulations, requirements, responsibilities, and costs, a foundation may be the best choice. If clients primarily want to efficiently make grants to their favorite charities, receive maximum tax benefits, are cost-conscious, desire simplicity, and have online record of previous contributions to their DAF or grants from it, a DAF is most likely the best solution.

Ken Nopar is the Director, Philanthropic Practice Management for the American Endowment Foundation.