Donor-Advised Funds: What Every Nonprofit Should Know and Why
By Elizabeth Thompson
Questions? Send an email to Elizabeth or drop us a note at cooperativeimpactlab.org
The dramatic growth of giving through Donor-Advised Funds (DAFs), giving accounts established at public charities, represents a shift in philanthropy. This article provides an overview of DAFs, both their growth and how DAFs work. By understanding DAFs, nonprofits can understand where the challenges are with DAFs. Many nonprofits still operate in a world that is culturally dominated by private foundations and their rules but that world is being eclipsed by the DAF world and its rules and norms.
First, a quick numbers review as to why you should pay attention to DAFs:
Donor-Advised Funds are Overtaking Private Foundations
Donor-Advised Funds now take in over 20% of individual charitable giving[i]. Even though DAFs have been used since the 1930s, there has been exponential growth in their use in the past 25 years.[ii]
The number of DAFs, the value of assets that DAFs hold, the level of contributions to DAFs and the grants from DAFs — by any measure there is year-over-year substantial growth, and there is no reason to think that the climb will not continue. In five years, from 2017 to 2021, the assets held in DAFs doubled from $120 billion to $240 billion.
This chart gives another view of the hockey stick pattern of increase for DAFs by comparing them to private foundations’ share of charitable individual giving over time. DAFs are overtaking private foundations as recipients of individual charitable giving.
The number of DAFs has increased dramatically for two reasons. One is that a few years ago most DAF sponsoring organizations had financial threshold requirements to open a DAF, which limited the number of DAFs. Now, many sponsoring organizations have dropped the minimum requirement. In addition, in 2016, the America Online Giving Foundation started DAFs in workplace giving.
The growth of DAF assets and accounts is occurring in a sector that is experiencing some contraction. Last year charitable giving declined, and the number of donors has been declining over the past few years. Giving Tuesday, a nonprofit organization built around encouraging and analyzing data on generosity, in its lookback for 2022, writes:
“the long-term trend of waning donor participation which started in 2012, experienced a sharp decline in 2022, with donors declining by 10% year over year… new-retained donors [those who donated in the prior year but never before] decreased drastically by 26.4%.”[iii]
Individual giving as a share of disposable personal income since 1982 has ranged from 1.7% in 2022 and 1995 and a high in 2005 at 2.4%[iv]. The level of giving as a percentage of disposable income has stayed steady over the years with a downward trend for the past four years.
DAFs are growing in a sector that is either staying the same size or contracting a bit. If you or your organization raise philanthropic funding, and DAFs have not already entered your universe, they will.
The Mechanics of Donor-Advised Funds: They work for the ease of the donor, not the nonprofit
How DAFs operate is very straightforward: A donor gives assets, usually cash or stock, to a sponsoring organization. That sponsoring organization is a charitable organization that then takes control of the money. It is then left to the sponsoring organization to give to another charitable organization, often called a “working charity”. The donor receives the tax benefits in the year of the gift, and the donor can advise on where the money goes from the sponsoring organization (thus the term Donor-Advised Funds), but there is no requirement that the sponsoring organization ever give any of the resources out to a working charity. Additionally, technically, sponsoring organizations can distribute assets of DAFs without the advice of the DAF holder.[v]
In a DAF world, for the working charity to receive resources, two separate transactions must occur:
- The transfer of assets from the donor to the Donor-Advised Fund housed in a sponsoring organization, which is organized under section 501(c)(3) of the federal tax code. There are different types of sponsoring organizations; this paper focuses on national or commercial sponsoring organizations. The largest ones in the US are Fidelity Charitable, Schwab Charitable, Vanguard Charitable, and National Philanthropic Trust. In 2022, these four organizations granted out $23.6 billion and received contributions of $41.44 billion. [vi]
- The transfer of assets from a DAF account at the sponsoring organization to the working charity.
Why have DAFs and sponsoring organizations in the first place since they are just intermediary organizations? What is the value added to a donor? US federal public policy has long encouraged the charitable sector. In 1917, during World War I, Congress created an individual charitable tax deduction in the federal tax code, which still exists today. In addition, the federal tax code exempts from federal tax organizations organized to serve the public good; this category includes nonprofits organized under Section 501(c)(3) which encompasses many of the working charities that we are familiar with. In the late 1960s, some powerful members of Congress believed private foundations were operating beyond their scope and needed to be reigned in. As a result, the federal tax code was amended to constrain private foundations and leave the rest of the charitable universe largely the same. DAF sponsoring organizations do not have the limits of a private foundation because they are 501(c)(3) organizations but they function in ways similar to a foundation because they are distributing resources.[vii] For example, private foundations have a minimum payout requirement; DAFs housed at sponsoring organizations which are 501(c)(3)s do not.
For high-net-worth individuals who are philanthropically inclined, DAFs are appealing. Private foundations can be complex to run, and DAFs offer a simpler method of philanthropy. DAFs can provide greater tax benefits to donors than a private foundation[viii].
The tax benefits and the ease of establishing and maintaining them also make DAFs appealing to people who want to give philanthropically but are not high-net-worth individuals. In many cases, it is as easy as moving money from a savings account to a checking account. If you know where you want your charitable dollars to go, all you need to do is provide advice to the sponsoring organization and they will make the contribution.
Whether a donor gives $1000 or $100,000 to her DAF, she gets the tax advantage in the year she gives the gift, and she can sort out where to give it later. If the donor is retiring or managing significant financial shifts, then it is attractive to get the tax benefit without yet deciding where the money will go.
From the sponsoring organization’s perspective, there are clear advantages to offering DAFs. The large so-called commercial sponsoring organizations like Fidelity Charitable have grown their DAF assets tremendously. While the DAF assets sit in a Fidelity Charitable for example, the commercial funds gain financial benefits that accrue directly to them. The commercial sponsoring organizations have no direct financial incentive nor requirement to move the assets out of the DAFs and into working charities.
DAFs are a bifurcated mechanism for charitable giving, divorcing the government-provided tax benefit of the charitable deduction from the actual giving of the assets to a working charity. This is at odds with Congressional intent which is for the charitable tax deduction to stimulate giving of “essential monetary support to front-line charities”. As recently as 2017, when Congress passed the Tax Cuts and Jobs Act of 2017 the House Ways and Means Committee report stated[ix]:
“The Committee believes that a robust charitable sector is vital to our economy, and that charitable giving is critical to ensuring that the sector thrives. For this reason, the Committee believes that it is desirable to provide additional incentives for taxpayers to provide monetary and volunteer support to charities. Increasing the charitable percentage limit for cash contributions to public charities will encourage taxpayers to provide essential monetary support to front-line charities.”
Impacts of DAFS on Nonprofits:
What does all this mean for working charities, i.e., 501(c)(3) nonprofits? Here are some of the impacts:
On the challenges side of the equation:
- Dollar flows to charities: Continued rise of intermediaries results in fewer dollars going to working charities each year. The number of individuals giving assets to charity has decreased over the past few decades, and more charitable revenue is coming from high-net-worth individuals. Helen Flannery of Inequality.org writes “[a]s of 2021, more than 1/3 of individual giving was diverted into intermediaries up from 5% 30 years ago. Individuals donated $326 billion to charity in 2021 but $50 billion of that money went to private foundations, and $73 billion went to DAFs.”[x]
- No required payout: DAFs do not have a requirement to pay out any of their funds, as compared to private foundations that have a 5% required payout each year. With more funding going to DAFs instead of directly to charities, combined with a lack of requirement for distribution, means that more funding is sitting in DAFs instead of moving into the field.
- Finding and building relationships with Donors: DAFs are not transparent. You cannot identify which donors contribute to DAFs, nor can you identify issue areas of interest to those donors. Private foundations are required to disclose contributors, but DAFs are not. Building relationships with donors is always a challenge for charities; DAFs add a layer of complexity.
- Visibility of donors to working charities: DAFs do not have to disclose the donor to the recipient. If a charity receives a gift from a DAF, they may or may not know who it is from, thus making it impossible to build a relationship with the donor.
- Expertise and experience in issue areas to help advise donors: Commercial sponsoring organizations, like Fidelity, are larger than most private foundations, yet are not staffed or structured to guide donors in grant-making. These commercial DAFs do not have understanding the different issue areas and being able to guide a donor is not a priority for their business.
Opportunities of DAFs:
- If a donor has established a DAF, that individual has already declared charitable intent and crossed the threshold of committing resources. DAFs represent an already preselected group of individuals who want to give to working charities. This creates a pool of potential donors, if it’s possible to identify them.
- DAFs can provide a way to incentivize giving for people who would not otherwise give.
- DAFs provide a way for charitable assets to grow in value, resulting in a larger corpus to give out to working charities.
- DAFs can, in some cases, encourage donors to give more than they would otherwise give.
From the perspective of the nonprofit sector, how do you net the opportunities and challenges presented by DAFs? If the number of donors and levels of charitable giving were increasing in an equitable manner to the range of working charities, then you could argue that DAFs were contributing to a healthy sector. However, that is not the case since the data indicates a decline in donors and dollars for the sector overall.
Perhaps DAFs are offsetting what could have been greater declines. The financial health of the nonprofit sector is complex with many inputs, but the challenges of DAFs are real for nonprofits and need to be addressed by policy and actions taken by DAF holders and sponsoring organizations. Nonprofit organizations, the very organizations that are supposed to benefit from the resources given to DAFs, should have an active role in addressing the challenges.
Elizabeth Thompson is a long-time organizer, non-profit executive, donor-advisor, and coach. She is exploring the impact of DAFs on the non-profit advocacy sector in collaboration with the Cooperative Impact Lab. You can read more of Elizabeth’s writing in her newsletter Tracking Change.
For more information or to connect with Elizabeth or CIL on this work, please go to cooperativeimpactlab.org and contact us.
References:
[i]Flannery, Helen, “Donor-Advised Funds Now Take in a Fifth of Individual Charitable Giving”, April 13, 2023, https://inequality.org/great-divide/donor-advised-funds-popularity/
[ii] Berman, Lila Corwin, “Donor Advised Funds in Historical Perspective”, ttps://lira.bc.edu/work/ns/8f73ede8–14af-451c-9e7e-92d6570e7a0f
[iii] Giving Tuesday Data Commons, “Rethinking Resilience: Insights from the Giving Ecosystem”, p.41 https://www.givingtuesday.org/2022-lookback-report/
[iv] Giving USA 2023 p. 54.
[v]Fidelity Charitable Program Guidelines, p. 12, https://www.fidelitycharitable.org/content/dam/fc-public/docs/programs/fidelity-charitable-program-guidelines.pdf
[vi] Giving USA: The Annual Report on Philanthropy for the Year 2022, (2023) Chicago: Giving USA Foundation, p. 154, 156.
[vii] Berman, p.14 et seq.
[viii]National Philanthropic Trust, “Giving Vehicle Comparison”, https://www.nptrust.org/donor-advised-funds/daf-vs-foundation/#:~:text=Donors%20receive%20an%20immediate%20tax,%25%20and%2030%25%20of%20AGI.
[ix] Congressional Research Service, “The Charitable Deduction for Individuals: A Brief Legislative History,” June 26, 2020, p. 11, https://crsreports.congress.gov/product/pdf/R/R46178
[x] Flannery, Helen, “The 2022 Giving Slump Exposes the Fragility of Top-Heavy Charity,” June 22, 2023 https://inequality.org/great-divide/giving-usa-2023-wealthy-donors/
