The bad news about commercial donor-advised funds is getting worse.

As my loyal readers know, I’ve been giving attention here and in national journals to the negative impact that the burgeoning popularity of donor-advised funds is having on traditional charitable giving. People have been dumping money into Fidelity Charitable and Schwab Charitable in record numbers, to the point where in 2011 they ranked as the number two and number twelve “philanthropies” respectively in terms of money received from donors. Their cousin, Vanguard Charitable, hasn’t been doing so badly either, ranking number 22 on the Philanthropy 400. (To put their success in perspective, numbers 20 and 21 on the list were the not inconsiderable fundraising machines of Harvard and Yale.)

Now comes word that Schwab raised three times as much in the last half of 2012 as in the comparable period the year before. Fidelity’s numbers – supposedly revealing a similar growth – are due out this week. This is a phenomenal level of growth.

So what’s the problem with these numbers? Isn’t all charitable giving good?

Well, not really. These aren’t really charities, other than for their IRS classification. These are, in my coinage, NINOs – Nonprofits In Name Only.

Because they are technically 501-c-3 public charities, these commercial donor-advised funds provide the same charitable tax deduction as soup kitchens and homeless shelters and schools. But instead of actually providing charitable good, the donated funds here are going into holding tanks, to be invested in (and make money for) their corporate sponsors. Though the presumption is that the funds will be granted to charity over time, in fact there is no requirement whatsoever that the funds ever go out for actual charitable purposes. And with commercial donor-advised funds booming, and with overall charitable giving flat, this means that less is going directly to organizations that need the funding now.

Let’s give a real-life example to show why this is a problem.

I ran into a friend of mine on a plane not long ago. He’s a financial advisor for a respected mainstream brokerage firm. He described a client of his who had dropped $100,000 into the company’s donor-advised fund. (Note that, while Fidelity, Schwab and Vanguard are the largest and most famous of the commercial donor-advised funds, dozens more proliferate. My friend’s firm, for example, has its own donor-advised fund.)

This client received a $100,000 charitable deduction when he created the donor-advised fund. But in the five years since creating that fund, he has designated only a single $1,000 grant to an actual operating charity. So back in 2008 his $100,000 charitable deduction saved him some $28,000 in taxes (and cost the U.S. government that same amount), supposing he was in the 28% bracket. But only $1,000 has gone toward actual charitable purposes since that time.

And my friend, the broker? He’s been receiving commissions for the last five years for his client’s “funds under management” that have been in the company’s donor-advised fund. Let’s say that my friend gets a half-a-percent fee on those funds. (I’m guessing at the amount, which tends to be tiered based on the size of the total relationship, but I think this is in the range.) That means my friend has earned about $2,500 ($500 a year for five years) in brokerage fees for his client to have left the funds in place, rather than distributing them to charity.

And my friend’s company? I’m guessing that between fees on the donor-advised fund itself and the fees on the investments in the underlying mutual funds, the firm and its charitable gift fund arm are getting some 1.5% a year, or $7,500 over the course of the last five years.

So to sum up, by making this $100,000 “charitable” gift the client received $28,000 in lower taxes; my friend the broker received $2,500 in commissions; and my friend’s company received $7,500 in management fees. Meanwhile charities received…. $1,000.

I think there’s a fascinating and infuriating double-standard.  On one hand employees of nonprofits are prohibited by ethical standards from receiving a commission for funds they raise for the charities that employ them. On the other hand, for-profit financial advisors now regularly receive commissions for funds they help direct to “charities” – i.e. commercial donor-advised funds.

Meanwhile early reports are that overall charitable giving in 2013 will be flat. So as more and more money is rushing into these commercial donor-advised funds, less and less is going to organizations that provide actual services. Not only does this trend make a mockery of the charitable tax deduction, but it has terrible public policy implications, sucking donations away from important causes into this venal vortex of crass self-interest.

It’s clearer than ever that the government needs to impose some regulation and make sure these funds actually go out the door to good causes. Currently there is no federal requirement that any contributions at all be made from donor-advised funds.  I urge that Congress impose a 20% annual pay-out requirement so that these enterprises become short-term vehicles for getting money out to nonprofits. This preserves the convenience of donor-advised funds for the donors, but it would ensure that the funds would go out to the community within a few years’ time.

Or to put it another way: is it too much to ask that “charitable giving” involve just a little bit of charity?

By the way: I’ve started the process of getting in touch with my Congresswoman and Senators about this issue. Will you join me?

Copyright Alan Cantor 2013. All rights reserved.

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23 Comments. Leave new

  • Jennifer Rickards
    January 28, 2013 2:25 pm

    Alan, are there any national efforts among nonprofits to address this with Congress?

    • Thanks, Jennifer —

      Well, no — I don’t think nonprofits have gotten themselves together to address donor-advised funds. Partly, this issue, though building steadily through the years, has only crested and become an obvious problem recently. (And very little has been written on this subject — I feel strange to be in the vanguard.) Partly, nonprofits are understandably loathe to bite the hand that feeds them — and nearly all nonprofits get some benefit from donor-advised funds, even if they would much prefer the money by-pass the donor-advised funds and come directly to them. Partly, community foundations (and the Council on Foundations, the trade organization for all foundations) have been vociferous defenders of donor-advised funds, fighting off any hint of regulation. So I don’t think the nonprofit community is in any way organized or vocal about this.

      There was a review of donor-advised funds by the Treasury Department, with a report published in December 2011. It basically white-washed donor-advised funds and said there’s no problem, nor any need for regulation. Sen. Charles Grassley (R-IA) hit the roof — he’s been very critical of donor-advised funds. I don’t honestly know how Congress might be moved to act, particularly as there’s now such a vested interest by deep-pocketed Wall Street firms and executives to keep this unsavory gravy train moving. But sometimes when something is wrong, you have to speak up, and if you’re right, eventually a majority of people will agree with you.

      • If Congress is discussing limitations on the income tax charitable contributions deduction, DAFs would be a great way to do that — and leave the general rules for charitable deduction alone.

        • I agree, James — and in fact that’s similar to a suggestions I made in an op-ed in the November 15, 2012 Chronicle of Philanthropy. I think donor-advised funds and private foundations are different from other charitable endeavors because of the deferred nature of the charitable impact. If they received a 50% charitable deduction, rather than the full deduction, that would cause donors to reconsider their giving — and would encourage them to give directly to the operating nonprofit.

  • John Krueckeberg
    January 29, 2013 9:51 am

    Half-way through your blog I determined I would post a comment asking you if you thought contacting our political representatives might be a solution — and then you ended the piece with that very topic. Great blog!

  • This is a fantastic discussion of another of the myriad problems raised by donor advised funds. I plan to send this to Senator Grassley’s office.

  • Peter Labombarde
    January 29, 2013 10:25 am

    Alan, I absolutely agree with you on these issues. However, an answer needs to be crafted to the clever question “Well, the wealthy get to set up permanent family foundations – shouldn’t these donor-advised funds be thought of as family foundations for the average Joe?” I think part of the answer should be requiring more aggressive spending down of foundation money, but the topic needs to be fleshed out. Thanks for your bringing this issue to the fore!

    • Thanks, Peter —

      I agree with you that family foundations, too, should spend down more aggressively than the current 5% minimum. But I’m not so taken by the notion that some people float about donor-advised funds being the family foundation for the average Joe. Who’s to say that either the average Joe or the very rich Joseph needs a vehicle for getting a charitable deduction and then stashing it away?

      At least private foundations have to spend something each year, and they are subject to much more transparency — in who their trustees are, what their operating costs are, and to whom they made grants — than are donor-advised funds, which hide in the skirts of the 501-c-3 public charity status of their sponsoring organizations and therefore don’t have to disclose these things.

      I think there very much is a role for donor-advised funds, most notably for people who sell a business or otherwise come into a significant amount of capital (and the related capital gains tax). If those people have an opportunity to make a significant charitable gift, the donor-advised fund allows them to drop that money into an account for later distribution. The key, though, it that then the funds should go out over the next few years. If they are so keyed up about creating a permanent charitable monument to themselves, they should go through the hassle of creating a private foundation.

      Throughout this discussion, I think we should, quite honestly, think a bit less about the sensitivities of the donors and a bit more about societal needs. Indeed, though I have spent my career listening to the needs of donors and urging my colleagues and clients to be more donor-centered, at this point we’ve reached a tipping point. I think we have to be a bit less donor-centered. Let’s help donors focus on impact. And let’s get the corrupting Wall Street incentives out of the system.

      • It is also important to note how DAFs help family foundations avoid their 5% payout since the foundation can meet its payout obligation by giving money to the DAF!

        • Great point, Ray. As you know, that’s something I talked about in an earlier post, “A Trail Runs Cold.” The private foundation, instead of making many small grants to organizations, makes a single grant to a donor-advised fund controlled by family members. That satisfies the private foundation’s 5% payout requirement — but none of us looking at their 990-PF tax form has a clue about who the end beneficiaries are. Or, for that matter, whether the funds have gone out from the donor-advised fund at all. (Again, they don’t have to.) None of this is what they had in mind when they instituted the charitable tax deduction nearly a hundred years ago!

  • Great article, Al. While it still has some of the potential downside of a Donor Advised Fund (the money doesn’t have to be donated for a while), the investment options in the Impact Investments Donor Advised Fund all have positive social and environmental impacts. Investment options include those that support community development and social enterprises, including Calvert Foundation Community Investment Notes (full disclosure, I’m on the Board of the Foundation). They have some very innovative investment options on their site. And, Impact Assets is a nonprofit “created to help solve the world’s toughest problems by catalyzing investment capital for maximum environmental, social and financial impact.” So, the investments are having a positive impact rather than just making money for a major Wall Street Firm. Definitely a good option that people should know about.

    • Good point, Kathy —

      I’ve heard (off-line) from other folks in the impact investment world, and thanks for the lead on where people can go.

      But, as you said, donor-advised funds, even those with more palatable investment plans and fees, still delay the eventual gift to charity.

      There’s another whole realm of donor-advised funds, where charities set up their own for the convenience of their donors — and to attract funds that eventually will be left to the institution. That seems to me to be a very complicated and expensive way of taking in funds that have rather marginal benefits for the institution (it’s not as though these funds are easy to administer if you’re not set up to do that). But I think it’s a case of if you can’t lick-em, join ’em. Schools (which are particularly susceptible to starting their own donor-advised funds) see the gush of money going to commercial DAFs, and they say to themselves, “I want to get me some of that!

  • Sharon Rivard
    January 30, 2013 9:58 am

    Good to see you this morning. I must say that I agree wholeheartedly with you on this. For people with a truly giving heart, this vehicle could work well but then I believe those people would tend to give directly to the charities. There has to be a mandatory significant spend down requirement for this to even exist as a “giving” option. Keep writing!

  • Albert K Henning
    January 30, 2013 1:17 pm

    I disagree. Your analysis is incomplete, considerably.

    My wife and I use Fidelity CGF. We can move securities upon which we have a very large capital gain, into FCGF. We can take a tax deduction in the year we make the move. This tax deduction occurs during our high-earning (and high marginal tax-rate) years, not during our low-earning (and lower marginal tax-rate) retirement. We make this move (sell the securities) many years in advance of when we otherwise would, in the absence of FCGF. The government does not get the capital gains tax off the top, leaving more money available to go to charities. The proceeds can increase in value over time, without accruing taxes to us. We ‘advise’ or direct FCGF to make donations (and have never been turned down). The only money Fidelity gets is the (low) management fee on the balance of the fund up to the point when we direct its expenditure.

    The truth for us: we are giving away far more money, both today and down the road, than we would have, without the ability to both reap the tax benefit, and re-direct the capital gains tax from the government to the charities of our choice.

    • Thank you, Mr. Henning, for taking the time to write. I appreciate your candor.

      You’re right: my analysis in this piece is incomplete. A thousand-word blog post is not adequate for a thorough analysis of the mechanics of donor-advised funds.

      In other writings and presentations I have made very much the same case that you make for contributing to a donor-advised fund, whether a commercial entity such as Fidelity’s, or a community foundation. There are significant tax advantages for doing just what you describe in your situation: making large gifts of highly-appreciated securities in a year when you have high earnings, thereby maximizing your charitable deduction and minimizing your capital gains tax. Another classic example is when someone sells a business and registers a large capital gain. It’s certainly better to make a major gift to a donor-advised fund than to try to get a large number of major gifts out to many organizations before the end of the year. And I agree: I have no doubt that the availability of donor-advised funds leads you and others to make larger gifts than you otherwise might.

      My objection is not to donor-advised funds per se. It’s to the fact that donors have no requirement to spend down those funds and to get them out to the community for good causes.
      My suggestion is that you do all that you and your wife have done, but that you then have to spend down at least 20% a year in grants. That’s for the simple reason that so long as the funds are sitting in your Fidelity Charitable account, no actual charities are benefiting and no people are being helped. Another critic of donor-advised funds, Boston College Law School professor Ray Madoff, suggests that all the funds be spent out over seven years. Either way, our notion is not to take away the option of creating or adding to your donor-advised fund. It’s simply to make sure that the funds go out to worthy causes. After all – that’s why you and other donors received a charitable contribution to begin with.

      As for the fees charged by the commercial gift funds: you only mention the fee charged by Fidelity Charitable on your actual account there – and I agree that that cost is not large. But the money in your Fidelity Charitable account is then invested in Fidelity Investments mutual funds – so there are investment management fees there for the parent corporation. Finally, in many cases donors’ financial advisors “manage” the funds at Fidelity, or, as in the case described in my post, oversee the funds at an internal donor advised fund. In those cases, the financial advisor gets a cut.

      Are these fees large for the services provided? We could argue about that. But I would assert that the commission going to the financial advisor is unseemly at best.

      Again, thanks.

      • Alan: I think your argument of investment people receiving commissions is not necessarily an argument against DAFs but is an indictment of all commission-based financial representatives (i.e., investments, life insurance). I am somewhat sympathetic to your argument. Most investment and life insurance people do not encourage charitable giving because it reduced their assets under management — there is an inherent conflict of interest for the “advisor.”
        But, the DAF accounts at investment firms are following standard industry practices and generally have no extra fees than the standard investment account. The question is — are the investment firms earning the fees they reap from these accounts? If they are, then it may be a valid payment — fees for quality advice. But, often there is almost no advice given for the fees charged.

        • I think you’re right, James — some other people, off line, have raised the larger issue of how financial advisors are compensated in general.

          That said, I think the financial industry — and specifically the purveyors of the commercial donor-advised funds — want to have it both ways. On one hand, they insist that their charitable fund arms are independent 501-c-3s with their own boards of trustees. That would imply that gifts to those entities are no longer the property of the donor. But somehow the donor retains an advisory role that is — wink-wink, nod-nod — de facto control over how the grants go out and how the funds are invested. And though the funds no longer technically belong to the donor, the donor’s financial advisor somehow gets credit for those funds and takes a cut.

    • It sounds to me that you like doing this because you don’t actually have to give away the assets until much later in the future, while taking a substantial tax benefit in high-earning years. In your post, I did not see any reference to any actual giving to charities — other than the hypothetical notion that some day charities will benefit. The problem is that these accounts become tax-exempt vehicles for people to build assets, take tax deductions, and help charity very little. During this process, the donor controls the assets like their own — even you admitted to having control of the assets by giving “advice” to Fidelity CGF, when everyone knows that Fidelity CGF will not do anything contrary to the account owner.

  • Jamea Chitwood
    January 31, 2013 10:02 am

    It is sickening! That’s a 10-to-1 return these firms and a horrble loss for the work of true nonprofits.

  • Wow. This is great information to share with our donors who may be considering this type of charitable giving. Charities need those dollars now to continue their work. Thanks so much for addressing this!

  • Unfortunately the only way to get Congress to do anything is to make it in their individual best financial or political interest.

    Maybe a few major charitable organizations should hire a lobbyist to pressure Congress to act now. The press photo of a crusading senator or congressman acting on behalf of giving money to the needy might capture his interest. To insure that significantly high percentages of the money actually get to the charities, a promised contribution to a Super PAC would seal the deal.

    It’s a sad day when the main purpose of a charitable contribution becomes the income tax deduction for the donor. Shame on all of us for allowing this and creating tax dodges disguised as charitable giving.

  • Alan,

    You are right on target with your thoughts on commercial DAFs. An annual distribution requirement strikes me as an excellent solution. Whether 20% is the right number could be argued with, but the concept makes perfect sense. While talks about tax reform and possible limitations being imposed on the charitable deduction continue in Washington, one would think that your example of a donor taking a $28,000 deduction for a DAF gift that distributes only $1,000 to charity in its first five years would grab the attention of our legislators. I would hope they would conclude that the solution is to require greater distributions from DAFs, not that the deduction is too high . . . but you never can be too sure when it comes to Congress.


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