When Should I Use a Donor Advised Fund?
Donor Advised Funds, an off-shoot of community foundations, have been around for nearly a century. They took off in the last few decades after Fidelity got IRS approval in the early 90’s. By 2015, the Fidelity Charitable Gift Fund, a Donor Advised Fund (DAF), overtook United Way to become the largest recipient of charitable funds in the US.
DAFs now represent about 10% of the nearly half-trillion dollars ($471 B) in estimated U.S. charitable annual giving. Overall DAF contributions are up 20%, while total charitable giving is up by mid-single digits. The number of DAF accounts is growing and the average size is decreasing as these become more mainstream.
DAFs are ‘a waiting room’ for charitable donations. The donor gets a current tax deduction, pays fees to a custodian (for instance, .60% for the first $500,000 by Schwab), and then later suggests when and to whom the money should go. Wait, ‘suggest’ you say? Yes. Technically the DAF has the final decision to whom they will send your money, although this is rarely an issue with a registered 501(c)3.
Critics of DAFs point out that they hold money that charities need today, and this is certainly a growing issue. But the same could be said about private foundations, which somehow escape the same criticism. Don’t they hold on to their capital and distribute it slowly over time? Yes, it’s true that Foundations are required by law to distribute 5% of their assets, and DAFs are not. In practice, DAFs are distributed in the 20% range, far higher than many established foundations.
One big challenge for charities and DAFs is that they don’t get the names of the donors and everything is effectively anonymous. This means they can’t build a relationship with donors, which deprives the donor and charity. This is potentially tragic! The social connection of giving is a big part of the happiness we get from being generous.
So what’s so great about a DAF? The biggest benefit for the donor is the ability to take all the tax deductions in one year but choose the charity and timing of the gift later. There are several situations in which this happens, the most obvious is when someone desires to donate money in a windfall income year but doesn’t know the charity they want to donate to. We have clients who have been in this position and we use Schwab Charitable.
That’s about the only situation in which I recommend using a Donor Advised Fund for clients. But check out the flow chart below to help you figure out whether or not to use a DAF or give directly to your favorite charity.
