Dear philanthropy enthusiasts and curious minds,
I want to talk about a topic that might not be on your radar but is constantly whispered about behind close doors: Donor-Advised Funds, or DAFs for short. These financial vehicles sound like a nonprofit's dream come true, but they're actually wreaking havoc on charitable giving.
What Exactly are DAFs?
A Donor-Advised Fund (DAF) in philanthropy is the most popular tax-efficient way nonprofits manage their funds. It is a giving account established for a public charity. The 501(c)(3) public charity manages and administers individual DAF accounts as the "sponsoring" organization. Donors contribute to the DAF in philanthropy, receive an immediate tax deduction, and then recommend grants from the fund to their favorite charities over time. Before we talk about why they're so terrible, let's discuss why DAFs in philanthropy are so popular.
DAF assets grew by 40% from 2020 to 2021. $234 billion sit in DAFs waiting to be used, up from $167 the previous year (Inequality.org).
Why Are DAFs in Philanthropy So Popular?
DAFs in philanthropy have exploded in popularity over the past decade, and it's not hard to see why. They offer several attractive benefits to donors, which has led to their widespread adoption.
Immediate Tax Benefits: One of the main reasons DAFs in philanthropy are so popular is the immediate tax deduction donors receive. When someone contributes to a DAF, they get an instant tax write-off, even if the funds are not distributed to a charity right away. This makes DAFs in philanthropy an appealing choice for individuals looking to reduce their tax burden.
Ease of Use: DAFs in philanthropy simplify the giving process. Donors can make a single contribution of cash, stock, or other assets to their DAF and then recommend grants to their favorite charities over time. This allows for more strategic planning and less hassle compared to making multiple individual donations.
Investment Growth: Funds in DAFs in philanthropy can be invested, potentially growing tax-free until they are granted to charities. This means that a donor’s initial contribution can increase in value, allowing for larger eventual grants. This aspect makes DAFs in philanthropy particularly attractive to those who want to maximize their philanthropic impact over time.
Flexibility and Control: DAFs in philanthropy offer donors flexibility and control over their charitable giving. Donors can decide when and where to make grants, adapting their giving strategy as their interests and the needs of the community evolve. This control is a significant draw for philanthropists who want to be actively involved in their charitable endeavors.
But the popularity of DAFs in philanthropy also puts pressure on smaller organizations to consider using them, even if it’s not the best option for their specific needs. For smaller organizations, they may struggle to compete with larger organizations for grants, be administratively challenging due to limited resources, and complicate financial planning due to unpredictable funding. So why are smaller organizations feeling pressure to use DAFs?
Donor Expectations: As more donors utilize DAFs in philanthropy, they may expect the charities they support to be able to receive grants from these funds. Smaller organizations that don’t adapt might risk losing out on potential donations. This expectation can push smaller nonprofits to set up DAF accounts, even if it complicates their operations.
Perceived Legitimacy: There’s a perception that using DAFs in philanthropy adds a layer of legitimacy and professionalism to a nonprofit's operations. Smaller organizations may feel that by adopting DAFs, they are signaling to potential donors that they are sophisticated and trustworthy, aligning with the practices of larger, more established charities.
Potential for Larger Donations: Since DAFs in philanthropy allow funds to grow tax-free, donors might be able to give more substantial grants over time. Smaller organizations might feel that by using DAFs, they are positioning themselves to receive these potentially larger donations, which can be crucial for long-term financial stability and growth.
The Double-Edged Sword of DAFs
According to the National Philanthropic Trust, DAF assets reached over $238 billion in 2022. But this rise in popularity is a double-edged sword. Here’s why DAFs in philanthropy are destroying charitable giving:
Delayed Giving: One of the biggest issues with DAFs in philanthropy is that while donors get an immediate tax break, the actual money can sit in the fund indefinitely. Unlike private foundations, which have to distribute at least 5% of their assets annually, DAFs have no such payout requirement. This means that billions of dollars earmarked for charity are just sitting there, not being used for their intended purpose. This opens the door for misuse of money that is supposed to meet urgent needs on the ground.
Lack of Transparency: DAFs operate with a significant lack of transparency. Donors can remain anonymous, and there’s no public record of where the funds are going. This makes it difficult to track the impact of charitable dollars and hold donors accountable for their giving.
Tax Shelter for the Wealthy: DAFs provide an easy way for the wealthy to avoid taxes while appearing philanthropic. They can donate appreciated assets like stocks to a DAF, avoid capital gains taxes, and get a charitable deduction all at once. Meanwhile, the funds can sit in the DAF for years, not being distributed to the charities that need it.
The largest takeaway about DAFs in philanthropy is that the money can sit in the account indefinitely, with no regulation of when they need to be used by.
Consequences of DAFs in Philanthropy on Giving
The consequences of DAFs in philanthropy on giving are far-reaching and often negative. Here’s how DAFs in philanthropy are impacting the landscape:
Stifling Immediate Impact: Because there’s no requirement for DAFs in philanthropy to distribute funds within a certain timeframe, the money doesn’t reach charities when they need it most. Especially in times of weather or natural disaster crises, immediate funding is crucial for nonprofits to continue their work and support vulnerable populations.
Skewing Donation Statistics: The rise of DAFs in philanthropy has skewed donation statistics, making it seem like charitable giving is on the rise when, in reality, much of the money is sitting idle in DAFs in philanthropy accounts. This gives a false sense of security about the state of philanthropy. Do you know where your money is going?
Decreasing Direct Donations: As more donors funnel their contributions into DAFs in philanthropy, direct donations to charities are decreasing. Nonprofits rely on predictable, direct funding to operate effectively, and the unpredictability of DAFs in philanthropy distributions makes planning and budgeting a nightmare.
All of these issues are feeding into the mistrust the public has about charities. A new poll of 3,000 Americans by the Independent Sector found that only 57% trust nonprofits, while trust in philanthropy remains steady at 33%. With growing popularity of DAFs and their coverage in the media, the results may be indicative of a further downward trend of trust in charitable giving.
The Post-COVID Philanthropic Landscape
The COVID-19 pandemic has been a wake-up call for the world in many ways, and philanthropy is no exception. Here’s how DAFs in philanthropy have influenced the post-COVID philanthropic landscape:
Increased Need for Transparency: With so many nonprofits struggling to survive during the pandemic, the need for transparency in funding has become more apparent. Donors and organizations alike are calling for clearer guidelines and accountability for DAFs in philanthropy.
Highlighting Inefficiencies: The pandemic highlighted the inefficiencies of DAFs in philanthropy in getting money to where it’s needed most. While some DAF sponsors did step up and expedite grants, the overall response was sluggish compared to direct donations.
Pushing for Change: There’s a growing movement to reform DAFs in philanthropy and make them more effective. This includes calls for mandatory payout requirements and increased transparency to ensure that charitable dollars are being put to good use.
Potential Regulation of DAFs in Philanthropy
Given the issues surrounding DAFs in philanthropy, it’s no surprise that there’s a push for regulation. Yet, philanthropy giants themselves spent $11 million to prevent changes to DAF rules. Here are some potential regulatory changes that could help mitigate the negative impact of DAFs in philanthropy:
Mandatory Payout Requirements: One of the most commonly suggested reforms is to impose mandatory payout requirements on DAFs in philanthropy, similar to the 5% requirement for private foundations. This would ensure that funds are distributed to charities in a timely manner.
Increased Transparency: Implementing measures to increase transparency, such as requiring DAFs in philanthropy to disclose their donors and grant recipients, would help hold donors accountable and provide a clearer picture of where charitable dollars are going.
Tax Incentive Adjustments: Adjusting the tax incentives associated with DAFs in philanthropy, such as limiting the immediate tax deduction to a portion of the donation until the funds are actually distributed, could help discourage the use of DAFs in philanthropy as tax shelters.
Better Alternatives to DAFs in Philanthropy
While DAFs in philanthropy have their benefits, there are better alternatives for managing and distributing charitable funds. Here are a few options that can have a more immediate and positive impact:
Direct Donations: The simplest and most effective way to support a charity is through direct donations. This ensures that your money goes straight to the organization, allowing them to use it immediately to further their mission.
Private Foundations: For those with significant assets, setting up a private foundation can be a more transparent and accountable way to manage charitable giving. While foundations do have administrative costs and regulatory requirements, they also have the ability to make a more direct impact.
Community Foundations: Community foundations are another great option. They pool resources from multiple donors to support local causes, often with a deep understanding of the community’s needs. This can provide a more targeted and effective approach to philanthropy to impact your local organizations.
Impact Investing: For those looking to make a difference with their investments, impact investing offers a way to generate financial returns while supporting positive social and environmental outcomes. This can be a powerful complement to traditional charitable giving.
Approximately 30% of Americans are familiar with private foundations and community foundations, but more than 52% of Americans have heard of them and are not familiar with them (Indiana University Lilly Family School of Philanthropy).
Additionally, DAFs are not well understood with the general public. Only 11.4% of polled American adults are familiar with DAFs in philanthropy. It's more important than ever to talk about these issues and bring more awareness to the general public about the dangers posed by DAFs in philanthropy.
Why These Alternatives Are Better in the Long Run
Choosing alternatives to DAFs in philanthropy can have several long-term benefits for both donors and the charitable sector as a whole:
Immediate Impact: Direct donations and other alternatives ensure that funds are put to use right away, providing immediate support to charities and the communities they serve.
Transparency and Accountability: Alternatives like private foundations and community foundations operate with greater transparency, making it easier to track the impact of donations and hold donors accountable.
Better Alignment with Donor Intent: By choosing more direct forms of giving, donors can ensure that their funds are used in ways that align with their values and intentions, rather than sitting idle in DAFs in philanthropy.
Encouraging a Culture of Giving: Promoting alternatives to DAFs in philanthropy can help foster a culture of active and engaged giving, where donors are more involved in the causes they support and more aware of the impact of their contributions.
Conclusion
While DAFs in philanthropy might seem like a convenient way to manage charitable giving, they’re actually causing significant harm to the philanthropic landscape. And since some of the largest nonprofits, family foundations, and philanthropic organizations are doing it, smaller charities feel a pressure to follow what is succeeding.
Approximately 80% of Americans believed that in-kind, charitable, and direct person-to-person giving were very or somewhat important (Indiana University Lilly Family School of Philanthropy).
From delayed giving and lack of transparency to serving as tax shelters for the wealthy, DAFs in philanthropy are destroying charitable giving in more ways than one. The COVID-19 pandemic has only highlighted these issues, showing the need for immediate reform and more effective alternatives. However, approximately 80% of Americans still believe that charitable giving provides societal benefit from a study in April 2023 by Indiana University Lily Family School of Philanthropy. Transparency is the currency of philanthropy. Without it, no one benefits.
By pushing for regulation, such as mandatory payout requirements and increased transparency, we can help ensure that charitable dollars are put to good use, to direct, local use. And by choosing alternatives like direct donations, private foundations, community foundations, and impact investing, we can all collectively make a more immediate and positive impact on the causes we care about.
Join the Donor Revolt for Charity Reform. This campaign is a call to action to reform private foundations, donor-advised funds, and top-heavy philanthropy. Learn more about how you can get involved here.
Comments