Financial advisors play a crucial role in helping high-net-worth clients achieve their philanthropic goals through effective charitable planning. Two versatile and effective means of charitable giving are through donor-advised funds and private foundations.
On Oct. 24, in the latest installment of our “Ask the Experts” webinar series, Gillian Howell, Head of Client Advisory Solutions at Foundation Source; Sandra Swirski, founder of Integer; and Gregory W. Baker, president and chairperson of Renaissance Charitable, provided an overview of these two charitable planning vehicles and the pros and cons of each, as well as reviewed some recent legislative activity around DAFs. They also answered attendees’ questions on DAFs and PFs.
Here, they answer some more of the pressing questions on the topic.
What’s the status of the DAF reform legislation, and will existing DAFs be grandfathered if that legislation is passed?
Swirski: Beginning in 2021, several prominent U.S. senators and representatives supported legislation, the Accelerating Charitable Efforts (ACE) Act, which would change the way DAFs operate and likely make them less appealing as a charitable giving vehicle. The bill scrapped the current structure of DAFs and created two new categories of the giving vehicles, one of which would offer better tax benefits to those who disburse assets within 15 years while the other would delay the tax benefits until the donor advises the assets out of the DAF. It also included provisions intended to prevent donors of complex assets, such as private stock holdings and real estate, from claiming tax benefits that exceed the dollar amount for which the asset is eventually sold. The bill also limited transfers of funds from PFs to DAFs except in certain circumstances.
The ideas in the bill continue to have champions, but the full bill isn’t pending before the House of Representatives or the Senate. That said, the Biden administration’s Treasury Department is expected to issue new rules related to pieces of the bill.
It’s unclear if existing DAFs would be subject to new DAF rules from Congress or the administration. As we say in Washington, the devil is in the details.
Increase in DAFs
Can you discuss what the rapid increase in DAF accounts relative to PFs means. Why is this happening? What are the implications?
Baker: As a general rule, DAFs are easier to create, easier to run, easier to use and more accessible than a PF. For example, a DAF can be created with almost any DAF sponsoring organization for as little as $5,000 or $25,000. It’s far more likely that a client will create a DAF at $25,000 than a PF. PFs have a place for clients and so do DAFs. They will continue to be vibrant tools used by clients to express their philanthropic desires.
What trends are you seeing in both DAFs and PFs, respectively?
Baker: DAF trends include more gifts of complex assets including business interests and hedge fund interests at the higher end of the spectrum. We also see more investment by DAFs in hedge funds and impact investments compared to a few years ago. While DAFs have grown in use, they’re still a relatively new and unused giving tool. Donors and grant advisors are making greater demands for online access to information about the DAF’s investments, charitable grants already paid and research into potential new charities. In the future, we’ll see greater integration of the DAF with other planning tools used by clients such as their individual retirement accounts and family trusts.
Howell: On the PF side we’re seeing a couple of things. More funders are trying remove hurdles for nonprofits so grant dollars can be awarded and deployed more rapidly. There are a few benefits to this, incuding the ability to align more effort and talent against program work versus fundraising or grant applications. We’re also seeing more PF engaging in cross-dsiciplinary and entrepreneurial initiatives to drive change over the long term. A few examples of this might be setting up awards programs for advancements in specific fields or funding multi-year projects that require time-intensive work (like clinical trials or data capture) to get policy makers or government agencies involved in subsequent stages. Focusing on the intersection of philanthropy, impact investing and policy can drive outsize outcomes, but it takes patience.
Distributions to Non-Chartiable Organizations
Can a DAF make distributions to an entity that isn’t a charitable organization?
Baker: DAFs can only grant to organizations for charitable purposes. It’s possible for a DAF to grant to an organization that’s not a charitable organization, but this is rare because it’s difficult for both the DAF sponsoring organization and for the grant recipient. The Internal Revenue Code contains a specific exception for grants to such organizations if the DAF sponsoring organization uses expenditure responsibility. This requires the DAF sponsoring organization to validate the money was properly and fully spent for the designated charitable purpose and to obtain and review complete reports from the grant recipient on how the money was spent. Most DAF sponsoring organizations feel the effort, time, cost and compliance of expenditure responsibility isn’t worth the effort or expense and they recognize it’s outside of their sweet spot.
Conversion of PF to DAF
Is there a way to convert a PF to a DAF?
Baker: Yes, on the surface it’s a simple grant from the PF to the DAF. But it’s a more involved process as the PF still has an ongoing annual requirement to produce a separate tax return each year of its existence and may have reporting obligations to one or more state entities. In addition, some PFs have entered into multi-year grant commitments. At a high level, the PF will generally need to grant most (not all) of its assets to the DAF, while keeping enough assets to pay its final costs. In some states, the State Attorney General will need to approve the charitable grant to the DAF. The Internal Revenue Service will need the final Form 990-PF return for the PF for the stub year and an official notice to the IRS that the PF is terminating. See Revenue Ruling 2003–13 for more details on this. It’s important not to provide this notice to the IRS any earlier than necessary, because PFs have a termination tax that’s based on its remaining assets. So, if the notice is provided to the IRS when the PF has zero remaining assets, the tax is also generally zero.
Determining Better Option
Is there a rule of thumb around a net worth value that helps determine if a PF or DAF is the better option? Or is it really about the charitable intent and better fit based on pros/cons?
Baker: As with most decisions, find out what the client wants and what they’re willing to do. Obviously, the available tax deduction benefits and the initial and ongoing costs are factors. In addition, look at the entire relationship. Running a PF generally requires more active engagement by the client or an individual they appoint, while a DAF generally doesn’t require as much active interaction. Will your client commit to that ongoing engagement year after year?
Howell: The way people want to give is one of the best determinants for choosing a charitable vehicle. PFs offer a complete philanhropic tooklit that allows for things like scholarships, awards programs, for-profit investments and loans and direct charitable activities as well as gifts to charities. And while there can be exceptions to this, we’ve found that $1 million is a reasonable threshold to consider. Running a PF with less may not make sense given the requirements.
I read that DAFs aren’t really designed to fit charitable intent in perpetuity. For sponsors looking to leave a multi-generational legacy, would you expect a PF to remain the more popular option?
Baker: Charitable intent will be followed because all money contributed to a DAF must irrevocably be dedicated for charitable purposes. A different way to think about this question is whether the DAF sponsoring organization will allow the donor’s family to continue to be grant advisors on the DAF in future generations. This feature varies by DAF sponsoring organization. Some, but not all, DAF sponsors restrict involvement by the donor’s family to one or two generations. However, many DAF sponsors permit the donor’s family to be grant advisors for unlimited generations. Regardless of whether your client is looking at a DAF or PF, it’s likely that future family generations will have widely different viewpoints on what’s a desirable charity from what the original donor would consider a worthy charity. Look at the Ford Foundation, which was created many decades ago by what most people would consider to be a conservative founder. Today, the Ford Foundation supports many charitable endeavors that the original founder likely wouldn’t have even considered.
Howell: PFs remain a great vehicle to support multi-generational family engagement because they present numerous opportunities to gather the family and work on mission and governance together. In addition, family members can volunteer or be employed at a PF, they can hold board positions, they can vote on grants (if desired) and succession plans can ensure the smooth transition from one generation to another. Many families use PFs as a way to express their values as a unit over the long-term, to one another and in their communities through the organizations and causes they choose to support.
Having both a DAF and a PF
Are there advantages for a family with a PF to have a ‘sidecar’ DAF?
Howell: There are many advantages for a family or individual to having both a private PF and a DAF and it’s quite common in the world of philanthropy today. There can be financial benefits as donors can potentially maximize their tax benefits by stacking their contributions (that is, giving to both a PF and a DAF) to maximize deductibility. Having both can assist in the strategic deployment of the PF’s 5% minimum distribution requirement. Rather than make a flurry of hastily considered grant decisions, or incur a penalty for missing the distribution requirement, the PF can grant the outstanding amount to their DAF to satisfy that requirement. This gives the donor additional time to decide how best to use those charitable dollars. Another advantage is ensuring complete anonymity in giving; PFs must record their grants on their annual tax return, which must be available for public inspection. DAF sponsoring organizations aren’t required to show which grants are associated with which DAF accounts. When making donations to a controversial or politically charged issue, the donor could grant funds from the PF to the DAF and make anonymous grants from there. This strategy can also be used to avoid a flood of grant requests from organizations similar to the ones being supported.
Does Size Matter?
Generally speaking, at what level of assets under management does it make sense to consider a PF over a DAF?
Howell: Under a $1 million, generally speaking, a DAF is the best option. However, in my opinion, once you get past the $1 million level, size isn’t the main driver in determining whether a DAF is a more suitable vehicle than a PF, rather the decision should be driven by what the donor or family wants: if they’re: (1) looking for simplicity, maximum tax deduction and anonymous giving, (2) to give exclusively to U.S public charities, and (3) not too concerned about perpetuity, then a DAF might be the best option. If, on the other hand, the donor or family is: (1) looking for full ownership over investments and grants decisions, (2) wants an option to choose their own board and if necessary compensate them, (3) is looking to give beyond U.S. based public charities, (4) wants to donate assets that don’t need to be sold, (5) would like to hand deliver grant checks and hire staff, including family members, then a PF is likely the best option.