Joan Harrington is assistant director of Social Sector Ethics at the Markkula Center for Applied Ethics. Views are her own.
What are donor-advised funds?
When we think of charitable giving by individuals, we usually think of tax-deductible gifts being given directly to active nonprofits. Active nonprofits are organizations that will use the money soon after receiving it for their own programming. Donor-advised funds (DAFs) are unusual because, in contrast to direct nonprofit giving, DAFs allow a donor to hold the donation in a fund at a “sponsoring organization” – but the donor still receives an immediate tax deduction.
Sponsoring organizations generally fall into three categories: community foundations, single-issue charities such as the Sierra Club or some faith-based charities, and commercial charities. Commercial charities are the charitable arms of institutions such as Fidelity, Goldman Sachs, Schwab, and Vanguard. There is currently no legal requirement as to when those funds should be distributed to active nonprofits. In 2017, the distribution rate of DAFs was only approximately 22%, which means that 78% of contributions remain locked in sponsoring organizations.
Although the donated funds legally belong to the sponsoring organization, most organizations honor the donor’s advice about when the funds should be distributed and to what nonprofits. This has led to an accumulation of assets as donors delay their decision-making for a variety of reasons. There were more than $110 billion in assets held in DAFs in 2017.
Donor-advised funds are growing at an extraordinary rate, especially at commercial charities. The charitable arms of Fidelity, Goldman Sachs, Schwab, and Vanguard are now four of the ten largest charitable organizations in the country. In 2017, Fidelity Charitable received more than $6.8 billion in DAFs — more than United Way Worldwide, the Salvation Army, and St. Jude Children’s Hospital combined.
As is evident from the headlines above, DAFs are under fire and donors are faced with the question of whether DAFs can be used ethically and if so how?
Why is giving to a donor-advised fund an ethical issue for donors?
DAFs raise ethical issues for donors because people and organizations may be negatively affected by donors using DAFs instead of direct giving.
The structure of DAFs encourages an endowment mentality, with donors working to grow the long-term potential distribution versus giving to charitable causes sooner. While this may be a thoughtful strategy on the part of some donors who wish to provide long-term support to a favored cause, it does not explain the low distribution rate of DAFs at a time when nonprofits struggle to sustain their services.
In an effort to reach an ethical decision about their use, donors should identify the stakeholders and consider the impact of DAFs on those stakeholders.
Nonprofits and their clients
Nonprofits need funds to effectively serve their missions, and their unmet need is high. Consider Silicon Valley. The 2018 Silicon Valley Index reported that 30% of all Silicon Valley households did not earn enough money to meet their basic needs without public or private, informal assistance. More than 10% of the population lacked continuing access to nutritionally adequate food and more than a third of Silicon Valley students ages 5-17 receive free or reduced-price school meals. Nonprofits report that they are unable to keep up with the growing need for services as they operate in a “high-cost, high-need environment.”
Basic human services, the arts, and educational organizations at the local, national, and global level would all benefit from access to additional funds. And yet, $110 billion sits in DAF accounts nationwide unused, and remains inaccessible for the sector that would help provide lacking services.
In addition, DAFs often create a communication barrier between nonprofits seeking to explain their services and their work, and their potential donors. The active advisory services of commercial charities are generally thin and even some community foundations do not regularly and systematically showcase local nonprofits. Nonprofits are further blocked from connecting with donors because most sponsoring organizations do not disclose the areas of interest or focus of their DAFs and donors.
Charitable deductions for donor contributions is effectively a subsidy from taxpayers. For every dollar not paid by a donor in taxes, the taxpayers pay more. This subsidy comes with the understanding that charitable organizations offer value and needed services to the public and that donors should be supported in their giving to nonprofits to address public needs.
The donor receives an immediate tax break when they donate to a DAF. The public has a justifiable expectation that there will be a benefit to the public when the deduction is given to the donor. When donors give to DAFs and immediately receive their tax deduction, but postpone gifts to charitable organizations, taxpayers are negatively impacted.
Those organizations that sponsor DAFs may be considered stakeholders as well. Commercial charities have significantly different interests than most community foundations and single-issue charities.
Community foundations and single-issue charities generally use DAFs to address needs of the populations they serve. Most community foundations focus on a defined, local geographic area and they work with donors to give to charities within that community. Similarly, single-issue charities encourage donors to give to organizations serving the identified cause. In contrast, commercial charities do not have plans for strategic giving and exist for the convenience of the donor.
All types of sponsoring organizations charge fees for administration and investment of DAFs and these fees differ by organization.
Donors are stakeholders as well, and the needs and interests of the nonprofits and their clients, taxpayers, and the sponsoring organizations should be weighed with the interests of the donor.
How can donors act ethically with respect to donor-advised funds?
- Determine whether using a donor-advised fund is critical to your giving.
Think carefully about whether giving through a DAF is the right way to give based on your needs and goals. Do you have the ability to give directly to a nonprofit without using a DAF? If so, it is likely that decision best serves the interests of the nonprofits and their clients, and taxpayers. If you do not have a nonprofit in mind, consider doing research in the coming year so you are able to give directly to nonprofits that fit your interests and goals as a donor.
- If you must use a DAF, choose the sponsoring organization with intention.
If you do not have a nonprofit in mind but want to give immediately to capture a tax deduction, you may choose to give through a DAF. Think about the different types of sponsoring organizations and the services they provide. Give to an organization that will best advise you and help you move forward with your giving in a way that matches your values and goals. Community foundations and single-issue charities generally provide more support to donors with respect to choosing nonprofits that are effective and fit donor interests and goals.
- Give away the funds as quickly as possible, unless you have a concrete reason for delaying giving that serves the nonprofits you seek to help.
If you choose to delay giving, think deeply about your reasons for doing so. In evaluating your reasons, weigh them against the needs of nonprofits and their clients and the interest of the public. What is your reason for delaying a gift?
- Is it your desire to accumulate funds so you may give in case of an emergency, such as a natural disaster?
- Are you trying to grow your gift or do you have a large fund that you want to extend over multiple years to help nonprofits in the long-term? Have you done the research to ensure this approach best meets the needs of the nonprofits?
- Are you helping to create an endowment at a community foundation or single-issue charity to address ongoing critical needs of a particular community or issue?
- Are you using the DAF as a tool for family philanthropy in the long-term? If so, are you striking the right balance between your desire to teach family members about philanthropy and the current needs of nonprofits and their clients?
4. If you have chosen to delay giving from your DAF, create a strategy for giving over multiple years.
Determine the types of nonprofits you would like to support and work with the sponsoring organization to determine which nonprofits are most effective at what they do. Work with the selected nonprofits to determine how to best support their needs over the long-term.
Congress, the IRS, and some states, including California, are considering changing the laws governing donor-advised funds. Whatever happens from a legal perspective, donors should consider whether the vehicle they use to make a charitable gift might be reducing the ultimate value to or even harming those they aim to help.