Some Nerve

It turns out that my last post, “Deluge,” really hit a nerve.

I received triple my usual number of blog hits, four times the usual number of on-line comments, and dozens of emails and phone calls, including some from professors, congressional aides, and financial advisors.

Here are my responses to some issues they raised.

One enthusiastic donor to Fidelity Charitable wrote that I didn’t understand all the tax advantages the commercial donor-advised fund offers to donors – and he said that he and his wife put much more into their gift fund than they otherwise would have given to charity.

I understand very well the advantages to the donor. Donor-advised funds are a particularly attractive vehicle if a person is selling a business – what in financial parlance is called “a liquidity event.” Along with receiving a large cash payment for the sale of the business, the successful seller also receives a big bill for capital gains taxes. These taxes can be offset to a large extent with a major gift to charity. But it’s tough for people, particularly folks who have been focused on the sale of their business, to suddenly have to give away, say, a million dollars to charity before the next December 31. So instead they pop the money into a donor-advised fund for later distribution. Charitable deduction now; charitable good later.

I’m actually very supportive of that: it makes more sense than creating a private foundation or throwing money out to charity in a panic. I have even encouraged this approach with some of my clients. What I’m against is keeping the funds in the donor-advised account indefinitely. Putting a requirement in place that 20% of the funds be distributed every year, or that the funds be distributed fully over the course of five or seven years, would not in any way take away the donor-advised fund option. It would merely accelerate the payments to charity.

One friend wrote that he knows someone working at one of the big commercial donor-advised fund, and she had told him that the average pay-out to charity from their fund is actually close to 20% a year. If that’s the case, what’s the problem?

This pay-out rate may be true – but it misses the point.

According to the National Philanthropic Trust’s 2012 Donor-Advised Fund Report, the average pay-out from donor-advised funds is 17.1%. That’s a handsome number, and more than three times the charitable distribution from most private foundations. So why am I complaining?

Well, an average is just that, an average. There are over 170,000 donor-advised funds, and people use them in vastly different ways.

For example, there are some donors (I know and work with some) who use the donor-advised fund as an in-and-out mechanism for their giving. They might drop $100,000 into their Fidelity Charitable account and get it out the door to charity within 12 months. They love the ease and simplicity of having Fidelity cut the checks, but it’s never a long-term arrangement. And for them, the annual pay-out rate is close to 100%.

Other donors send their funds out at 20% or more a year, along the lines of what I’m suggesting as a minimum.

Others treat their donor-advised fund as a permanent entity – putting out 5% or so a year. They want to preserve the principal for the next generation.

And still others are like the fellow I highlighted in my last column: they put funds in, get their deduction, and pretty much leave it untouched. Their pay-out is essentially 0%.

My proposal wouldn’t affect donors in the first two categories at all, but it would goose those in the last two categories to give away a significantly higher amount more quickly. My attitude is that if people are intent on building a permanent charitable vehicle, they can and should create a private foundation. But giving away the money from a donor-advised fund at a high rate is not a hardship, and it’s vastly better for society.

An advocate for community foundations chided me for not differentiating between commercial gift funds, like Fidelity, and geographically-based community foundations. The latter, he asserted, are much more philanthropic.

Indeed, community foundations serve their communities in many ways, and donor-advised funds are simply one tool they use for getting funds and attention to the right causes. Community foundations hold a variety of funds – some unrestricted, some directed toward a particular field, and some even to support a single organization – that combine to sustain good works in a community.

And yes, the distasteful dynamic by which brokers receive commissions for directing their clients’ money to donor-advised funds – what I called the “venal vortex of crass self-interest” – is not present with community foundations.

And yet the same dynamic that I object to most about donor-advised funds – that the money sits unproductively rather than going out to operating charities – characterizes community foundations as well. In fact, the average donor-advised fund at community foundations actually pays out only 12.5% a year, compared with 17.8% a year at commercial gift funds, and 24.7% a year at donor-advised funds established by large charities. (These figures, again, are from the 2012 Donor-Advised Fund Report of the National Philanthropic Trust.) This low pay-out rate isn’t surprising, as community foundations have long marketed themselves as a way to have an impact on the community in perpetuity. (Many have tag lines saying something like, “For Poughkeepsie, forever.”)

Moreover, some community foundations give donors a “recommended spending rate” of 4% or 5% a year, letting their donors know how to keep the purchasing power of the fund consistent through time – that is, to make the fund perpetual. That makes sense from a business standpoint, because most community foundations support their operations by levying a fee based on a fixed percentage of fund balances. If the principal balances of the donor-advised funds dwindle, so too do the community foundations’ operating funds.

So, yes, community foundations do many positive things, including providing leadership for the nonprofit sector and amassing grants and attention for critical issues. Unlike the commercial gift funds, they are genuine 501-c-3 public charities. But they too hoard the money in donor-advised funds, rather than distributing dollars to worthy nonprofits. Those funds could be put to better use in the community.

One professional fundraiser wrote in LinkedIn that he doesn’t like donor-advised funds any more than I do, but I should simply accept that they aren’t going away. “We have to learn to live with them.”

I agree that donor-advised funds aren’t going away. So I’m trying to suggest rules – most notably an aggressive, required pay-down rate – so that we can live with them. Unless we as a nation rein in donor-advised funds, they will increasingly undermine the nonprofit sector they are theoretically established to support.

Copyright Alan Cantor 2013. All rights reserved.