At a time when nonprofits (and their donors) are still struggling to recover from the devastation of the Great Recession, one sector of philanthropy is thriving: donor-advised funds. In my view, that’s not necessarily a good thing. Let me explain why.
Some background: Donor-advised funds function similarly to private foundations, but without most of the hassle, overhead, paperwork, and tax disadvantages. Individuals or families make a gift to a certain kind of 501-c-3 nonprofit (traditionally, a community foundation), and they get the full tax benefit of a contribution to charity. Though the funds have already been donated to the nonprofit, the donors retain the right to designate which other nonprofits should get grants from these funds in subsequent years. Technically donors’ recommendations for grants are only advisory, with the final decision made by the sponsoring nonprofit, but it’s very rare indeed for a grant suggested by donors not to gain approval.
Donor-advised funds have never been more popular. Donations to most charitable sectors are fairly flat, with overall giving rising only 0.9% in 2011, adjusted for inflation, according to Giving USA. But in recent years donations to donor-advised funds have boomed. Contributions to donor-advised funds went up 25% from 2009 to 2010, reaching a level of $7.7 billion. And in 2011, donations to the three largest commercial donor-advised funds (more on those below) rose by 77%. This is statistically significant – and somewhat troubling.
It’s not that donor-advised funds are inherently bad. The issue is that the funds going into donor-advised funds are not addressing immediate needs. Writ large, charitable giving is a zero-sum game. If one sector starts attracting significantly more money, that comes at the expense of other sectors. And if the area that’s booming essentially warehouses the charitable funds (sometimes indefinitely), as is the case with donor-advised funds, that means less money is going to meeting today’s needs. The simple truth: if more is going into donor-advised funds, less is going to human service agencies, schools, orchestras, and other institutions that need funding today in order to deliver important services.
There are two reasons for the growth of donor-advised funds. The first is that they are, frankly, very attractive to donors. Donors get a major charitable deduction when they need it for tax purposes and can then designate the money to individual charities at their leisure.
The second reason for the growth is the increasing dominance of commercial gift funds. For several decades, the primary organizations that housed donor-advised funds were community foundations and religious denominations. But in 1992, Fidelity Investments established the Fidelity Charitable Gift Fund. The Fidelity Charitable Gift Fund is technically a 501-c-3 charitable organization (a designation that many of us questioned when it received that status). It has a board of directors distinct from Fidelity Investments, though all of the money in the Fidelity Charitable Gift Fund is invested in Fidelity mutual funds.
Dozens of other for-profit corporations soon followed Fidelity’s example and got into the donor-advised fund business. Today the three largest are Fidelity, Vanguard, and Schwab – and they are, annually, listed among the nation’s biggest nonprofit organizations. For 2010, the Fidelity Charitable Gift Fund ranked as America’s third-leading nonprofit in terms of donations, behind only the United Way and the Salvation Army. (If you find it strange to have an organization affiliated with a major mutual fund company listed among the largest charities in the country, you’re not alone.)
Once the attractiveness of a donor-advised fund was combined with the marketing power, investment expertise, and on-line capacity of the Schwabs and Vanguards of the world, donations took off markedly. In 2010 gifts to donor-advised funds captured 3.6% of all charitable giving from individuals, and the trend is pointing upward. Will donations to donor-advised funds soon make up 10% of all charitable giving? Twenty percent? What does that imply for the nonprofit community needing current support?
Defenders of donor-advised funds will point out that, on average, they distribute a high percentage of their assets annually – and I will grant them that point. But the fact is that more money is going into donor-advised funds than is going out. And I find one fact hard to swallow: an individual donor-advised fund is not required to distribute even a single penny in a given year.
I’m a relatively lonely voice in publicly criticizing donor-advised funds, but I’m in a chorus of millions singing for an overhaul of the tax system. If and when that happens, could we consider reinserting some public policy logic to the charitable deduction, so that a taxpayer would actually have to provide immediate benefit to society to claim the deduction? Couldn’t we require each donor-advised fund to distribute a significant amount each year – perhaps even stipulate that the funds be distributed fully within seven years, as Boston College Law School professor Ray Madoff suggests in a New York Times op-ed? And wouldn’t it make sense to tier charitable deductions, so that donations to donor-advised funds and private foundations would trigger, say, only 50% of the deduction that an outright gift to an operating charity would bring?
Suggestions like these will no doubt agitate a lot of people operating within the current philanthropic system. I don’t in any way question the motives or integrity of those who support donor-advised funds. But if changes such as those I suggest could result in more funds going immediately to help fight hunger, homelessness, illiteracy, lack of opportunity, and environmental disaster, then I say that this is an apple cart worth upsetting.
Copyright Alan Cantor 2012. All rights reserved.
Bold article Al! Thanks for the big picture thinking, as always.
Al, what is the logic or justification in a donor advised fund existing without the mandate of distributing charitable funds annually? Can you help me get my mind around that?
Thanks, Brian — and I can understand why you have a hard time getting your arms around this issue.
The notion is that a donor-advised fund is part of a 501-c-3 public charity. The charitable moment legally occurs when the donor makes the donation to establish (or add to) the donor-advised fund. Legally, the donor is making an outright gift and is only retaining an advisory role. From that point on, the legal responsibility for the use of the funds falls to the 501-c-3’s board of directors.
It’s a bit of a legal fig leaf, from a skeptic’s point of view. That said, with a traditional donor-advised fund at a community foundation, there is a review process by the staff before grants go out; the foundation plays a role in educating the donor on the best use of the funds; and foundation staff often work with donor-advisors to collaborate on large, collective grants to important community efforts. By contrast, that sort of effort does not take place with the commercial gift funds, where it’s a more brazenly transactional relationship controlled to all intents and purposes by the donor.
The government says: these are 501-c-3 organizations. They have boards of directors. There is inherent good for society by making the initial gift. Hence, there’s no pay-out requirement. They view private foundations differently. There, because they are not public charities with an independent board of directors, they require a minimum pay-out of 5% a year.
So there’s legal justification for not having a spending mandate. But you’re right — it’s hard to make sense of how these funds are not required to go to actual operating nonprofits providing services. From a societal standpoint, there should be an expectation for spending down the donor-advised fund.
I’ll add one other caution. If there is a mandate to spend down from donor-advised funds, we should be wary of the law of unintended consequences. When the IRS imposed a minimum spending rate of 5% on private foundations, that became the de facto MAXIMUM spending rate for most private foundations. Donor-advised funds, for all their flaws, average a pay-out of 16% or so a year. I’d hate to see the government impose a minimum mandated pay-out of 5% or so — and see donors use that as a guide and have the actual pay-out rate drop!
No easy answers for this, I’m afraid. But you’re asking the right question!