[Note: This was cross-posted October 1, 2014 by the National Committee for Responsive Philanthropy.]
Arthur Schopenhauer said, “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”
I’m no expert on German philosophers, but Schopenhauer really nails it. Just think of the cause of marriage equality, which has followed exactly that course, passing from ridicule to violent opposition to acceptance as self-evident over the course of the last twenty years.
The effort to reform donor-advised funds (DAFs) does not have nearly the societal ramifications of the marriage equality issue. That said, donor-advised fund reform is an enormously important issue for American philanthropy, and when viewed through a Schopenhauerian lens, the effort has recently transitioned into the second phase of truth: violent opposition.
A little background: Donor-advised funds have seen tremendous growth in recent years, with donations to DAFs rising 105% over the last four years. DAFs are a you-can-have-your-cake-and-eat-it-too philanthropic vehicle. Donors get a full charitable deduction when they make a donation to their fund, but they retain the right to say how the funds should be distributed to charitable causes in the years that follow. But no money needs to go out the door to actual operating charities in the year of the gift, or ever. Instead the funds can remain invested in accounts at the sponsoring organizations, which range from community foundations to religious federations to, most recently, entities created by Fidelity, Schwab, Vanguard and other financial services firms.
Why is this a problem? Well, the federal government subsidizes donations to nonprofits through the charitable income tax deduction. The notion behind the charitable deduction is that these donations are for the public good. It’s easy to understand how a gift to a food pantry is for the public good. But it’s hard to understand how a gift to Fidelity Charitable is for the public good. After all, why should a donor get a charitable deduction in 2014 for money that won’t go out to charitable purposes for years – and perhaps not ever?
I can hear my friends in the donor-advised fund industry (and I do still have some, which is a tribute to their patience) howl as they read this. “But it is for charity!” they attest. To which I answer: but charitable distributions are not required. Until the money is granted from the DAF to operating charities, the funds are simply invested in the markets, making money for Wall Street and doing nothing for society.
Consequently, I support the proposal by Ray Madoff, professor at Boston College Law School, that money contributed to donor-advised funds needs to be distributed to charity within seven years. That seems like a common sense reform. People who are in a position to make a big gift in 2014 – say, if they sell a business and have lots of capital gain and tax liability – can put money in their donor-advised fund right away and then have until 2020 to get that money out to homeless shelters, youth programs, schools, museums, and other charities.
When Madoff and I were two of the very few people in the country who were advocating for this required spend-down, we were gently ridiculed. “Unnecessary,” one person told me. “What exactly is the problem you’re trying to solve?” Our views were dismissed as fringe and unimportant.
Then, in the spring of this year, a man named Dave Camp publically agreed with us. In fact, he said the required pay-down should be completed in five years, not seven. And the reason his opinion matters more than those of people named Madoff or Cantor or Jones is because Dave Camp is the Chair of the House Ways and Means Committee, and the DAF spend-down proposal was folded into his extensive proposal for federal tax reform.
At that moment, reaction to the proposal shifted from ridicule to violent opposition. The spend-down notion was no longer an annoyance but a threat. My favorite over-the-top reaction was a hastily-summoned webinar by the Alliance for Charitable Reform (ACR). The speakers, all representatives of the donor-advised fund industry, shared an irate and condescending tone. In high dudgeon they emphasized the efficiency of DAFs compared to private foundations, ignoring the obvious fact that the real comparison should not be between two entities (DAFs and private foundations) that warehouse charitable dollars, but between gifts to donor-advised funds and outright gifts to operating charitable organizations. “There are not enough charitable dollars to go around!” declared Brent Christopher, CEO of the Communities Foundation of Texas, on the webinar. Christopher thought that this was an argument for letting donor-advised funds operate as they have been; to my mind the shortage of charitable dollars is a big reason for requiring DAFs to distribute money.
Rather shockingly, the ACR webinar featured Jeff Zysik, the CFO of Donors Trust, a DAF sponsor. Donors Trust gained notoriety, as I wrote in March, for effectively laundering politically-motivated charitable contributions by Charles Koch. That the Alliance for Charitable Reform chose to showcase one of the nation’s most discredited donor-advised fund mills as an exemplar of the industry demonstrates a remarkable degree of tone-deafness.
A line heard throughout this webinar and in other similar defenses of DAFs is that a requirement that the funds go out to charity within a set number of years would constitute an unwarranted and damaging governmental intrusion into charitable giving. And, at the same time, these Libertarian-flavored spokespersons insist that the charitable deduction for gifts to DAFs be left untouched. In short, government should stay out of their way – other than to continue to deliver a tax deduction to the donor. (Hypocrisy? You be the judge.)
What are the chances for common-sense, meaningful reform of donor-advised funds? That is, will DAFs ever be required to actually dispense money to charity? There are certainly obstacles. Most notably, DAFs are a cash cow for Wall Street, and we know that Wall Street, in large measure, tells Congress what to do. Very little legislation passes these days without a sign-off from the financial services industry.
But I have faith that when a growing majority of people sees the truth, the right thing happens.
Most people without a stake in the current DAF structure are frankly shocked when they learn that donor-advised funds provide donors with a full charitable deduction, but that the money can then sit there indefinitely without any required charitable distribution. And once the number of people thinking this way reaches a tipping point, Congress will finally enact a pay-out requirement for donor-advised funds. The nation will no doubt see this as an action that was overdue, logical, and, of course, self-evident.
Copyright Alan Cantor 2014. All rights reserved.
This is very exciting news, Al. Thank you for sharing it. You and I “are of one accord” on this topic. I’m interested in hearing your opinions at some point about donor management regarding DAFs and how to counteract the financial media machine that and capturing more and more charitable dollars for their own benefit.
No doubt many regular citizens, including myself , have become educated about this through your very informative blog!! Keep up the good work, and I look forward to future updates!!
OK, DAF’s should be required to make distributions within 7 years, but how much? The whole boodle? If only part of it, what part? Where the DAF goes to a community foundation, it becomes part of an endowment which is normally expended at the foundation’s spending rate, which can vary among foundations and over time, within a foundation. Would such distributions meet the proposed requirement? How frequently within the 7 year period would such distributions have to be made?
How would the proposal deal with these issues?
Thanks, Martin, for weighing in.
The proposal from Prof. Madoff, yes, would call for the full amount donated to a DAF to be distributed within seven years. Given that some people add to their donor-advised funds periodically, the donations would need to be tracked, from an accounting standpoint, as First In, First Out. Donors could distribute the funds at any point during the seven-year period. And one of Madoff’s suggestions is that donors designate a charity in advance, so that any unspent funds would go to that cause at the end of year seven.
This is obviously a different model than how community foundations historically have managed DAFs, but not as different as you suggest here. Yes, the assets in donor-advised funds are co-invested in most cases with the community foundation’s endowment assets, but the spending rates from DAFs are usually not tied to the overall community foundation endowment spending rates. Virtually all community foundations allow for spending from the fund that is either above or below the overall endowment spending rate. That is, if someone has a $100,000 fund, the community foundation might suggest, as many do, that he or she consider spending, say, $4,500 in order for the DAF to be consistent with the overall spending rate of the foundation and to preserve the purchasing power of the funds there. But the donors are fully empowered to recommend spending $10,000, or $50,000, or even the full $100,000 in a single year. Or they could spend nothing at all. Most community foundations allow total flexibility in spending.
The reason Ray Madoff and I and other critics are looking at this issue is because of the huge surge in donations to DAFs in recent years. Donations to DAFs rose 105% from 2009 to 2012, and in 2012 comprised fully 5.7% of all gifts from individuals to charity. (As a percentage of gifts to secular purposes, it’s closer to 8%.) The amount donated to DAFs in 2012 was $13.7 billion, which is actually four billion dollars more than all the money donated to conservation, environmental, and animal rights groups combined. We’re talking real money here. That’s a huge drain, to my point of view, from gifts to operating nonprofits. And the numbers for 2013 (yet to be released) will no doubt be higher still.
I know that this proposal is disruptive to the way that community foundations do their work and to how families treat their DAFs, but I would assert that it’s in the public interest (particularly at a time of greatly diminished governmental support to nonprofits, as well as shrinking corporate support) to flush money out of DAFs and into the community. At the end of 2012, there was $45 billion sitting in DAF accounts — with a growing percentage, of course, at commercial gift funds like Fidelity, Vanguard, and Schwab. (Fidelity alone holds over $10 billion in DAF assets. That’s three times the endowment of Dartmouth College.)
I’ll add one other problem with DAFs. The rules governing DAFs have what Prof. Madoff refers to as a “a wink and a nod” quality to them. The reason donors are given the same charitable deduction as a gift to a soup kitchen or a school is that donations to DAFs are considered an outright gift to a public charity, with the donor only retaining an advisory role. But we know that the the donor retains de facto control, so long as the beneficiaries are genuine charities — and that point is clear in any of the websites marketing donor-advised funds. Essentially, the DAF sponsors tell prospective donors that it’s a mini-private foundation without the hassle or expense — and the donations are treated in the same way gifts to public charities are treated, rather than the more restrictive way gifts to private foundations are treated. This was not so much of a problem when the primary purveyors of DAFs were community foundations, but the volume of giving generated by the commercial gift funds has made this into a public policy problem that can’t be ignored.
Were these rules to be enacted, it might make sense for funds that are already in place to be treated more leniently. But I feel strongly that some kind of action needs to be taken. It’s not in the interest of the nation for us to subsidize charitable gifts that are providing only a muted and deferred charitable return.
Bravo! Again. There also will be a challenge to educate philanthropists who rely on the DAF’s to accomplish their tax goals in consideration of philanthropic intention; and others who think that a fund in perpetuity at a Community Foundation is in the best interest of social reform.
Donor Advised Funds (DAFs) are an example of charitable resources that generate fees which support the work of community foundations. This author certainly doesn’t understand the critical value of your Community Foundation’s fees on DAFs if he can say:
“Until the money is granted from the DAF to operating charities, the funds are simply invested in the markets, making money for Wall Street and doing nothing for society”
Actually they represent an important investment in local philanthropy education and other services provided to our communities. And that is charitable work made possible at the moment after a gift comes into a community foundation DAF.
Also he claims that DAFs are not subject to the same spending policy as other community foundation funds, not true here for our endowed DAFs. One community foundation, one spending policy.
Thanks, George, for weighing in.
I need to mention first off that in fact I do understand how the operating fees generated by DAFs support the larger work of community foundations. I worked at a community foundation for six years, and I even sat on the national community foundation leadership team at the Council on Foundations back about 15 years ago. I may be guilty of seeming somewhat cavalier in ignoring the impact of this proposal on community foundations, or in lumping community foundations together with the commercial gift funds. But my opinion is not based on ignorance of how the system works.
Certainly a challenging issue in dealing with donor-advised funds is that those sponsored by community foundations are nestled within what I consider legitimate community-based nonprofits, while those at the commercial gift funds (Fidelity and its ilk) are housed at what I call NINOs — Nonprofits In Name Only. And certainly community foundations provide extremely valuable service to the donors, to the grantees, and to the community. And I’m sorry if I presumed that all community foundations have a similar approach to managing and investing DAFs. Given that community foundations — and there are hundreds — are all independent entities, I was wrong to assume that the model I’m most familiar with is used by all. Thanks for correcting me.
Certainly adoption of the Madoff seven-year spend-down rule, or something similar, would present some significant operating challenges to community foundations. That said, protecting the operating income model for community foundations is not a viable reason for stopping a reform that would serve the country at large well. Tax deductions are supposed to serve the greater good. Truly, my support for the Madoff proposal is not at all designed to hurt community foundations, but to help underfunded nonprofits and the people they serve. Does a million dollars in an endowed DAF at a community foundation help the community by supporting the community foundation and its work? Certainly! Would the funds do even more good if they were distributed to organizations directly involved in providing housing, food, healthcare, and education? To my mind, absolutely.
I also feel a need to point out that, while I was wrong to imply that funds at community foundations are only making money for Wall Street, they are indeed doing that as well. Managing community foundation assets and nonprofit endowments of all types is big business for the financial services industry, and I feel as though the profit motive from Wall Street exerts a certain gravitational pull on donors and institutions. The default for major gifts, at community foundations and at most nonprofits, is to lock up the funds in a permanent endowment. Certainly Wall Street’s profit motive is not nearly so explicit in the community foundation world as at the commercial gift funds. Nor do community foundations support what I consider the pernicious and unethical practice of providing financial advisors with commissions for referring clients/donors, as do the commercial gift funds. But, coldly analyzed, the funds at community foundations do indeed make money for Wall Street. They do much more, of course, and most of that is very good, but they do make money for Wall Street.
I would encourage community foundation leaders to spend less time adamantly fighting this spend-down proposal and more time re-imagining how they could reconfigure their business model to accommodate it. I’m happy to engage in that conversation — and I have already done so with individual friends in the community foundation world.
Thank you for getting your opinion out there. I welcome other comments on this issue!
Alan, George is a colleague of mine in the CF world, so he forwarded the exchange between you and him to my attention. I would very much appreciate the opportunity to speak further with you about your ideas for community foundations “reinventing”. The ACF is part of a community foundation coalition in New Mexico that is exploring consolidation/merger and specifically looking at how we remain relevant for philanthropy over the next 100 years. I hope to connect with you.
Thanks, Randy. Let’s talk! I don’t have the answers, but it might be helpful to kick around ideas. I’d enjoy that. Give me a call!
Excellent post. So, what advice would you have for a nonprofit looking to take advantage of the surge in DAFs, while also advocating for common-sense spend-down legislation?
A good and difficult question.
There’s a power differential here. The donors and the sponsoring organizations have the money and the control, so it’s hard for nonprofits to scream and demand that they spend down their money. That power differential also explains why it’s very hard to get nonprofits to chime in to support efforts to rein in donor-advised funds. Biting the hand that feeds you, after all, is a sure route to malnutrition.
But I think it’s important for nonprofits to understand what’s going on, and to gently pressure on the donors to do the right thing. If a donor says she is building up a donor-advised fund, it’s fair for nonprofits to ask if her intention is to keep it as a permanent fund or to spend it down. The donor may not even realize that she can spend it down and get it out the door to good causes. By raising the subject, you may get the donor to think differently about the fund.
It’s also important for nonprofits to get to know the staff members at their local community foundations, who in most foundations make a good effort to understand what’s going on in the community and help their donors direct their grants to the best possible causes. A good community foundation functions as a connector between donor and nonprofit.
Alas, this option doesn’t exist with Fidelity and the other commercial DAFs, which are purely about carrying out the orders of the donors. The commercial DAFs are not grantmakers who care about program impact. They’re simply about the transactions. They actually handle the transactions well, but there’s no way for nonprofits to get to know donors through the commercial DAFs.