Philanthropic giving isn’t just your run of the mill financial transaction. While it is true that a well-rounded charitable contribution strategy can help alleviate your tax burden, sharing your resources is highly personal. Donating to the charities or foundations you care about not only benefits the charities themselves, but can be deeply rewarding for the contributor, as well.
When setting up a philanthropic giving strategy, you may wonder whether you should give directly to the charitable organization or set up a more formalized planning vehicle, such as a Donor Advised Fund (DAF) or private foundation. The key is to choose the strategy that both maximizes the financial impact of your contributions while also supporting the causes most important to you.
When making the decision on how best to donate your resources for both mitigating tax liability and overall impact, we often advise clients to take a closer look at both Donor Advised Funds and Private Foundation strategies. What we find most useful for our clients is in helping them weigh the relative merits of each so they can make the decision that will be most personally fulfilling and financial rewarding at the same time.
Donor Advised Funds (DAF)
A Donor Advised Fund (DAF) is an account that a donor establishes within a public non-profit sponsor organization—such as a community foundation, university, religious organization, or financial institution—that is set up to manage charitable contributions on behalf of individuals, families, and organizations. Within a DAF, donors are able to contribute cash, real estate, and other financial business assets to the charities of their choice over time.
One of the most attractive features of the DAF is the ability to chunk donations into a single year, but have them distributed to your charity of choice over a period of time. In years when clients can use a higher deduction for tax purposes, we help them contribute up to 5 years’ worth of donations into a single year. They can then have the donations dispersed over the following 5-year period. This way, they get the tax break when they need it, but they can still continue to support the charities relying on their donation year after year.
There are a few drawbacks to a DAF, though, with the first being that there are some restrictions on giving with a DAF. For example, you can’t:
- Use money in a DAF to fulfill a pledge you’ve already made to a given organization.
- Buy tickets to a benefit or gala that provides a benefit to you (such as an event admission or dinner).
- Pass DAF funds along to your heirs (depending on the organization). Many DAFs have rules about how their funds should be designated after you die.
Plus, there are associated administrative and investment fees assessed by the organizations themselves. While the fees tend to be relatively moderate—around 0.6% of assets plus the investment fee—we do include the fee schedule in our meritorious assessment of each DAF our clients consider.
A private foundation, like a public charity or public foundation, is dedicated to carrying out a charitable mission. But unlike a public charity which relies on public fundraising to support its activities, the funding for a private foundation comes from a single individual, family, or corporation which will receive tax deductions for its donations. Foundations can be started with and hold most any kind of asset including (but not limited to) tangible assets, real estate, and intangible personal property. There are some limitations, though, to holding family business assets.
With a private foundation, the donor—or board of directors—maintains complete control over the mission of the foundation, where the funds are invested, how and when funds are distributed, and who to elect to the board.
What clients planning for generational wealth transfer like most about this option is that a private foundation can be set up to exist in perpetuity. As long as the foundation exists, the giving can continue and it can become a family heirloom that is passed down from one generation to the next.
The Bill and Melinda Gates Foundation, The Getty Foundation, and the Ford Foundation are some of the most popular examples of this giving strategy in action.
Major Differences Between a Donor Advised Fund (DAF) and a Private Foundation[i]
Before making a decision, we always want our clients to be aware of the implications of their choice. Exploring the following differences between the two options can really help us narrow their focus and hone in on the right option.
1) Account vs. Legal Entity
A DAF is an account that is opened with the intention of distributing its contents to charity, while a private foundation is a legal entity that must operate as such.
2) Who Is in Control
One of the major differences between these two vehicles is who remains in control of the funds. Because DAFs are accounts within a sponsored organization, donors can recommend how funds are invested, but the sponsor organization must approve.
3) IRS Rules for Distribution
The IRS has no requirement for DAFs on an annual payout amount or when funds must be granted to public non-profits, whereas the IRS requires private foundations to payout 5% of net investment assets each year in the form of grants or eligible administrative expenses.
4) Administrative Duties
DAFs do not have to file tax returns, thus lessening the administrative burden.
Because DAFs do not file tax returns, they can be a more private, anonymous giving option.
6) Family Legacy
DAFs typically only last one or two generations, whereas private foundations are often designed to exist forever.
A Long-Term, Sophisticated Solution to Charitable Giving
While there is certainly nothing wrong with check-book giving, or donating cash each year, it simply doesn’t provide that long-term strategy many of our clients need to (1) mitigate their lifetime tax burden or (2) safely pass generational wealth onto their heirs. When we incorporate a more sophisticated strategy like a DAF or private foundation, though, we help lay the groundwork for a vehicle that supports a client’s giving and family legacy over time.
[i]https://www.ncfp.org/knowledge/how-do-donor-advised-funds-compare-with-private-foundations-and-other-vehicles/ 7 April 2022