Donor-Advised Funds: Democratic Giving Vehicles or Crafty Tax Shelters?
For the past ten years, Donor-Advised Funds (DAFs) have become increasingly a popular, albeit controversial, giving vehicle. The principle behind DAFs is simple: Donors make charitable contributions to a DAF and recommend where and when this money goes. The money can remain in the fund for years before making its way to a charitable organization, whilst donors receive an immediate tax deduction. This simple explanation shines a light on why DAFs have accumulated as many avid supporters as critical opponents. And since they are philanthropy’s fastest-growing giving vehicle, representing 3% of all giving in the United States alone, it is not surprising that DAFs are fueling so many debates in the non-profit sector.
DAFs were initially set up in the early 1930s to regulate charitable giving and provide wealthy individuals with incentives to contribute to philanthropic initiatives. However, these financial structures further shifted the power balance between private and public entities and reinforced private control of wealth. They legally allowed wealthy individuals to “park” their charitable assets for future (and uncertain) public use, and to retain their individual control of these funds’ movements, whilst escaping progressive tax regimes. As we face an increased privatization of public goods and services, DAFs represent yet another area of privatized hegemony, often at the cost of independence, equality, and society’s communal benefits. And this increased private control over charitable funds and their giving flows is significant when you are talking about $85.5 billion (based on most recent data)!
The sheer size of charitable assets invested in DAFs is evidence enough of their popular yet problematic nature. For many, giving through a DAF is a tax-efficient way to conduct philanthropy. Charitable assets placed in DAFs can be invested before they are granted out. Thanks to market growth, DAFs grow, and more money becomes available for charitable grant-making. This benefit has been emphasized by many supporters, including most recently a group of leaders of community foundations that manage DAFs. They argue that the money is actually being used to help their communities and that many critics obsess about DAF’s inflows, whilst failing to look at actual charitable outflows. Opponents assume that if DAFs did not exist the money would automatically make its way to non-profits. But for many, DAFs are the only cost-effective option to make a donation when complex assets giving is involved.
Some are now calling DAFs
“the thing that ate philanthropy”
And DAFs have become the number one charitable giving vehicle because of this cost-effective versatility and flexibility they offer donors. Donors can create multi-year commitments. They can build legacy giving by involving their families in new ways. They can also convert illiquid assets, such as real estate, into philanthropic capital. They provide an alternative to setting up private or family foundations, thereby reducing the administrative burden associated with these structures. Proponents also claim that DAFs have helped democratise philanthropy because donors do not need to be millionaires to open a DAFs. In fact, a person can open an account with as little as a $5,000 donation.
Nevertheless, DAFs have yet to deliver on their democratization and charitable promises. DAFs often most benefit the world’s wealthiest, appealing to investors with capital gains, when most low to middle income people lack such assets. The average DAF donors remain individuals with annual income over $1 million, and the vast volumes of DAFs accounts belong to high net worth investors. And some of these wealthy individuals have been using DAFs solely as tax-saving schemes. Donors can actually avoid moving money to an active charity. So they can invest their money and immediately claim their tax breaks, whilst not sending the money to a charitable entity. As a result, society loses out on the public benefit of charitable giving, tax costs increase, and wealthy donors retain their tax benefits, control, and, ultimately, power.
And some are now calling DAFs “the thing that ate philanthropy”. As more assets accumulate in DAFs, less money actually flows to charitable organizations that need it right now. The $85.5 billion invested in DAFs effectively represents a pool of patient capital that could be poured into charities that are currently addressing the world’s biggest challenges. And, yes, the advantages to donors are tremendous, but numerous worthy non-profit organizations cannot even access these assets, namely due to a lack of personal connections to these wealthy account holders. It is understandable why the non-profit sector is wary of the popularity of DAFs, as many accounts can serve as tax shelters with little regulations or accountability, especially when compared with the growing scrutiny and transparency demands placed on the charitable sector.
Interestingly, DAFs reforms are being proposed, such as requiring distribution of donations within a fixed number of years and implementing a delay in tax deductions until after the funds are distributed to active charities. However, supporters worry that such reforms would eliminate the positive attributes that make DAFs attractive. Others have suggested connecting DAFs with impact investing, to allow investors to align their portfolio with philanthropic causes they are passionate about and to address ongoing concerns that DAFs are “warehousing important philanthropic dollars.”
The future of DAFs remains unclear. They can become a flexible giving vehicle that unleashes socially-just and environmentally-friendly impact investing, but to do so, they require more regulations and scrutiny to prevent the wealthiest from abusing the system at the expense of societal good. In the end, philanthropy should go beyond the use or disuse of DAFs, which represent only one of many effective charitable vehicles. Thus, we would like to encourage you, and other charitable humans, to reflect on your beliefs and values about philanthropy, and to decide how best to ensure that your vision for a better world is actually realized. Then it becomes only about choosing the right vehicle to do so!
Director of Strategy