[Note: This article was co-posted February 25, 2015, in Inside Philanthropy.]
The unbridled growth of donor-advised funds (DAFs) is the biggest story in philanthropy. Some startling facts:
- Contributions to DAFs were 252% higher in 2013 than in 2009, and by all accounts 2014 was another record-breaking year.
- Three of the top ten organizations in the Chronicle of Philanthropy’s most recent “Philanthropy 400”—the annual listing of the nonprofits that have raised the most money—were commercial donor-advised fund sponsors (Fidelity, Schwab, and Vanguard). A fourth was another DAF sponsor, the Silicon Valley Community Foundation.
- Gifts to donor-advised funds represented 7.1 percent of all charitable donations from individuals in 2013, a doubling of DAFs’ percentage of charitable giving from only three years before.
This is more than a trend. It’s a tsunami. But what does this all mean for the nonprofit sector?
Representatives of the donor-advised fund industry, of course, are thrilled by this explosion in popularity. They say that donor-advised funds are increasing the amount of money being contributed to charity. They talk about how donor-advised funds democratize philanthropy: DAFs, they say, are the regular person’s version of a private foundation. And in a circular bit of reasoning, advocates assert that DAFs must be a good thing, because donors would not be rushing to them otherwise. That is, the very success of donor-advised funds proves their value.
I have to disagree, strongly. The surge in donor-advised funds is not increasing charitable giving, but is actually siphoning donations away from struggling nonprofits. DAFs are, by and large, instruments for the very wealthy, not the common person. And the single strongest reason for the growth of donor-advised funds is not their inherent merit, but the profit motive: Financial services firms have figured out that DAFs are an easy way to make money from charity, and they’re doing so very effectively.
Let’s dispel the notion that donor-advised funds are encouraging more charitable giving. Americans have been remarkably consistent over time with their generosity. According to Giving USA, charitable contributions have hovered at or around 2 percent of disposable personal income for the last four decades. In 1991, the year that Fidelity Charitable came into existence, charitable giving represented 1.8 percent of disposable personal income. In 2013, that figure was virtually the same: 1.9 percent. Obviously, because of inflation and economic expansion, there are more dollars flowing from individuals to charity today than 25 years ago. But charitable giving hasn’t grown as a percentage of the economy or of people’s income.
So people aren’t giving more to charity. They’re simply directing more of what they give to donor-advised funds. The DAF industry insists that if donors weren’t setting up donor-advised funds, they’d be creating private foundations, and I’m sure that’s true in some cases. But there was 7 percent growth in the number of private foundations between 2012 and 2013, so foundations are not exactly withering away as a philanthropic option. In fact, the explosive growth in DAFs is coming at the expense of direct donations to nonprofits that provide actual services. People are giving to donor-advised funds instead of the food pantry or the Boys and Girls Club. And those gifts to donor-advised funds are accumulating: At the end of 2013, DAF assets topped $53 billion.
Donor-advised fund advocates will counter by saying: “What’s the problem? The money is eventually going to go to charity!” Well, not necessarily. There is no federal requirement that the funds are ever distributed. Yes, many DAF sponsors push their donors to make grants, but often these distribution expectations are laughably low. I called Schwab Charitable a while back expressing interest in establishing a fund. I asked if, once I created my DAF, I actually had to make distributions to charity. The representative replied, “Well, if you don’t make any grants in five years’ time, we’ll call and ask you to make a distribution.” She then added, reassuringly, “But our minimum grant size is only $50, so that shouldn’t be too hard.” Indeed.
One reason Schwab and other commercial donor-advised fund sponsors are not terribly eager to push their donors to distribute grants is that their affiliated corporations make a lot of money from the DAF investments. How it works is fairly simple: If you establish a donor-advised fund at Schwab Charitable, you are given a set of investment options—all managed by the Charles Schwab Corporation. So the longer the funds are invested—and, with some donors, the money sits there indefinitely—the more Charles Schwab earns in fees. The same goes, of course, for Fidelity and the other commercial gift funds.
And a critical point about this arrangement: The donors’ financial advisors are making money off the deal. When financial advisors refer their clients to commercial gift funds like Schwab or Fidelity, they usually retain the role of investment manager for the DAF—which is to say, the financial advisors will receive a fee. And financial advisors don’t have to bother sending the money outside of their own brokerage firm. Virtually every Wall Street firm now has its own in-house donor-advised fund. So here’s the reality: If a client makes a gift of stock to a homeless shelter, her financial advisor loses income. If, instead, she transfers that same stock into a donor-advised fund at the firm, her financial advisor keeps drawing management fees. Guess which kind of charitable gift the financial advisor is inclined to encourage?
Many people ask how Wall Street firms became purveyors of charitable gift funds. The first commercial fund designated a public charity was Fidelity in 1991. I don’t know what went through the minds of the tax regulators who approved it that day. Did they honestly think that Fidelity Charitable was going to be a truly independent nonprofit entity? Maybe they were asleep at the switch, or understaffed, or out-lawyered. All I know is that the IRS ruling declaring Fidelity Charitable a 501(c)3 public charity did to American philanthropy what the Citizens United Supreme Court decision did to American politics: It opened the floodgates to the wrong kind of money.
As for the notion that donor-advised funds democratize philanthropy? Well, that phrase sounds wonderful, but it doesn’t really mean much of anything. First, people don’t need an intermediary fund, whether a private foundation or a DAF, in order to be philanthropic. A person can be philanthropic by giving money directly to charity. And let’s not pretend that donor-advised funds are created by middle-class people. Yes, it’s possible to establish a DAF for only $10,000 or so, but the average fund size at the end of 2013 was over $247,000. A quarter of a million dollars is not pocket change. Let’s be honest: Donor-advised funds are primarily established by the very wealthy.
As Boston College Law School Professor Ray Madoff has written, DAFs are the kudzu of philanthropy, growing relentlessly and choking out the native species—that is, the genuine nonprofits.
So how to rectify the situation and restore some sort of charitable equilibrium?
To my mind, the most logical way to rein in donor-advised funds is to require distribution of the money within a set number of years. This idea was first proposed by Madoff in a New York Times op-ed in 2011. Madoff suggested a seven-year spend-down, so that donors could still make a major gift to their DAFs in a high-income year (and thereby manage their tax burden), with the funds then applied to actual charitable use within a reasonable period of time. This idea gained greater prominence last spring when Rep. Dave Camp, then Chair of the House Ways and Means Committee, signed on to the Madoff plan and upped the ante by proposing a five-year required spend-down.
The Camp spend-down proposal has fueled a vehement response from the DAF industry. Donor-advised fund leaders say that the Camp proposal represents government overreach and interference. They claim the proposal would suppress charitable giving and would take away options for philanthropists.
To which I say: If the option being removed is the ability of a rich donor to receive a full charitable tax deduction without ever having to distribute a penny to charity, then I’m all for it.
Let’s assign donor-advised funds their proper role—as a tax-advantaged way to encourage charitable giving, with charitable distributions required within a few years’ time. The spend-down requirement would benefit the community and provide relief to stressed nonprofit organizations. And this change would help return the notion of “charitable” to a central place in the practice of charitable giving. Is that really so terrible an idea?
