Donor Advised Funds vs Private Foundations

By Zeke Anders on February 14, 2022

Written By: Zeke Anders

Charitable giving can be a deeply rewarding use of your wealth. It feels good to give back to the organizations that support you, to help your community, or fund research devoted to a worthy cause. There are tax benefits as well, of course. Charitable giving can be deducted from income tax up to certain limits and can reduce estate tax without limit. The charitable deduction for income tax has been less beneficial since the Tax Cuts and Jobs Act increased the standard deduction in 2018. One way to maximize the deduction is to bunch donations or grants into a single year. The challenge is that you may not know which organizations you would like to make grants to, or the institutions themselves might not be ready to receive a large lump sum. Establishing a donor advised fund or a private foundation allows you to make a large gift, claim the deduction, and then make grants to charitable organizations and causes over time. Both strategies will allow you to accomplish similar goals, but there are some key differences between them.

A donor-advised fund is a section 501(c)3 organization that allows individuals to make a contribution to a fund that qualifies for the charitable income or gift tax deduction, and then invest and make grants to other charitable organizations with the funds. Donor-advised funds have become popular in recent years due to tax law changes and ease of set-up. Contributions can be made in the form of a variety of assets including cash, appreciated securities, land, cryptocurrency, and more. Donations of cash to a donor-advised fund can be deducted up to 60% of adjusted gross income and donations of appreciated assets can be deducted up to 30% of adjusted gross income, though this can vary depending on asset and basis. The fund will generally sell the assets, and then allow the donor to invest in other securities or funds or make grants. The investment options will vary by fund and may be limited, though some will allow for professional management of the account. Most donor-advised funds will have minimum initial contributions and a tiered fee structure based on the account balance. There’s currently no requirement to make grants from the account, meaning the assets could remain invested in the account indefinitely. (However, a proposal was made in 2020[i] that would require distributions from donor-advised funds, even though the average donor-advised fund payout rate was 23.8%). For legacy purposes, some donor-advised funds will allow the donor to name a successor, but in general they are not designed to last multiple generations. Lastly, gifts from a donor-advised fund can be anonymous.

A private foundation is your own not-for-profit organization. With a private foundation, you establish a new entity with bylaws and a board of directors. The main benefits to a private foundation are control and legacy. With a donor-advised fund, the account holder requests that the fund make grants to a charitable organization. The fund will almost always honor grant requests, but they are able to deny them. Additionally, a donor-advised fund is limited to making grants to IRS qualified charities, whereas a private foundation has more flexibility in making grants such as to individuals, creating scholarships, and more. A private foundation can be an enduring vehicle for passing on your values to future generations as well. You can appoint your children to the board of the foundation and share with them what organizations and causes you value and set an example of philanthropy. They, in turn, can add their own children to the board. Private foundations, unlike donor-advised funds, are required to grant 5% of their assets annually, but with prudent investment the foundation might still grow over time. Donations of cash to a private foundation can be deducted up to 30% of adjusted gross income, while donations of securities and other assets can be deducted up to 20% of adjusted gross income. There is an excise tax of 1.39% on net investment income for a private foundation. A private foundation must provide certain information to the IRS during set-up and in annual tax returns, such as grants, salaries, trustee names, and other information available to the public.

The bottom line is that both donor-advised funds and private foundations provide an opportunity to make a large charitable donation within a year, deduct the gift from your taxes, and make grants to charitable organizations and causes in smaller increments over time. A donor-advised fund is faster to establish and easier to maintain, but is potentially limited in terms of granting options and longevity. A private foundation requires more up-front work and maintenance, but allows more control and flexibility of granting, and can become a family venture that lasts for generations. A private foundation might make more sense for those looking to make larger gifts, typically greater than $1 million. The costs of starting and maintaining a private foundation can be mostly fixed, comprising of legal and accounting fees, as well as wages or salary for any support staff. When spread out over a larger amount of assets, these costs can be competitive with donor-advised funds. Either structure is a great vehicle for philanthropy, but the tradeoffs of each should be weighed carefully to find the best vehicle to accomplish our goals.

[i] https://www.nptrust.org/reports/daf-report/

Zeke Anders – Planning Specialist zanders@twickenhamadvisors.com

Disclaimer

Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.