The Complete Guide to Donor Advised Funds Versus Private Foundations
The Complete Guide to Donor Advised Funds Versus Private Foundations
An in-depth breakdown of the benefits and drawbacks of Donor Advised Funds and private foundations and the rules, tax benefits, and set-up/ongoing requirements for each giving vehicle.
Posted on April 11, 2024 by Katherine Fox.
The Complete Guide to Donor Advised Funds Versus Private Foundations
Should I set up a Donor Advised Fund or a private foundation?
If you’re deciding between a Donor Advised Fund (DAF) or a private family foundation to further your philanthropic giving, this is the guide for you.
I’m Katherine, and I’m a wealth manager and philanthropic advisor for multigenerational families. This post compiles questions I’ve heard from my own family, clients, and friends over the past decade.
Keep reading for an in-depth breakdown of the benefits and drawbacks of private foundations and Donor Advised Funds and the rules, tax benefits, and set-up/ongoing requirements for each giving vehicle.
If you’ve read through the guide and still don’t know whether a DAF or a Foundation is right fit for you, schedule a call with me to discuss your questions and get the answers you need to move forward.
When does it make sense to set up a Donor Advised Fund versus a private foundation?
Donor Advised Funds have exploded in popularity in recent years, drawing interest because of their flexibility, ease of use, and low expenses.
But for individuals and families with charitable assets above $5 million who are looking to build a plan for multigenerational family philanthropy, especially if there is a desire to provide income for family members working for the foundation, a Private Foundation may be a better fit.
Deciding whether to set up a Donor Advised Fund or a Private Foundation hinges on the following questions:
What is the overarching goal and impact thesis of my philanthropic giving?
How much money will I be giving away in total?
How much money will I be giving away each year?
Will I have friends, family, or other loved ones involved in charitable giving with me?
How involved or active do I want to be in charitable giving annually?
How do I want to invest my charitable dollars?
How much do I want to pay to set up a charitable giving vehicle?
How much of a tax deduction do I want for setting up a charitable giving vehicle?
What is my ongoing capacity for administrative details and expenses?
Do I have a specific non-profit I want to support with my annual giving?
Do I want charitable giving with my assets to continue after I die?
This guide will explore the details of Donor Advised Funds and private foundations, giving you the information you need to make an informed decision based on your answers to the above questions.
The Complete Guide to Donor Advised Funds Versus Private Foundations
What is a Donor Advised Fund?
A Donor Advised Fund (DAF) is a charitable investment account used to grant money to 501(c)(3) organizations.
When you contribute money to a Donor Advised Fund, you no longer own those assets. Instead, they are held by your DAF custodian, such as Charles Schwab, ImpactAssets, or a local Community Foundation.
You receive a charitable deduction in the year you make the gift into your Donor Advised Fund.
After funding a Donor Advised Fund, there are no requirements for how much or how often you are required to grant out funds.
As the donor, you get to “advise” on where those assets are granted out. This means that your granting requests need to be approved by your DAF custodian.
In practice, this is generally not an issue. Donor grant requests are almost always approved.
The main reason Donor Advised Fund granting restrictions come into play is with DAF custodians who limit recipient organizations. For example, a Community Foundation in a progressive city may restrict DAF gifts to organizations accused of promoting hate speech.
Money in a Donor Advised Fund is invested in the stock market. Depending on the size of your Donor Advised Fund, you may invest in a pre-set portfolio, manage your portfolio, or hire an investment advisor who specializes in philanthropy to manage DAF assets on your behalf.
What is a Private Foundation?
A Private Foundation is a charitable vehicle set up by an individual or family to support their charitable giving and philanthropic objectives.
Private foundations manage and invest charitable assets and grant assets out to other organizations.
There are two primary types of private foundations:
Private Non-Operating Foundations
Private non-operating Foundations are what most people think of when they think of foundations. They serve their charitable mission by making grants to charities, rather than by operating programs.
Private Operating Foundations
Private operation foundations are directly involved in operating or sponsoring a non-profit organization. They have the structure and are funded like a private foundation, but they operate programs like a public charity and are treated by the IRS as such.
Setting up a private foundation requires working with a qualified attorney to incorporate a private foundation and draft its governing documents. Once the foundation has been incorporated, it must apply to the IRS for recognition as a tax-exempt charity.
Foundations are required to grant out 5% of their total assets each year and must also make annual tax filings.
Family members or friends can be employed and receive a salary for the work they do with a private family foundation.
“Donor Advised Funds have exploded in popularity in recent years, drawing interest because of their flexibility, ease of use, and low expenses.
But for individuals and families with charitable assets above $5 million who are looking to build a plan for multigenerational family philanthropy, especially if there is a desire to provide income for family members working for the foundation, a Private Foundation may be a better fit.”
What are the pros and cons of a Donor Advised Fund?
Pros of a Donor Advised Fund
Donor Advised Funds are easy to set up.
DAF’s can be created easily online through many different providers, including financial custodians, DAF-specific providers, and Community Foundations.
Donor Advised Funds do not require annual tax or legal filings.
Once a Donor Advised Fund is created, it technically belongs to the sponsoring organization - the institution where you DAF is held. This frees you from annual legal or tax requirements.
Gifts from Donor Advised Funds are private.
Donor Advised Funds offer an easy way to anonymously grant out funds.
Donor Advised Funds are inexpensive to set up and operate and do not require ongoing administration.
Fees for donor advised funds are generally between .60% and 1% for the sponsoring organization, with an additional up to 1% fee if your assets are managed by an investment advisor. Because a Donor Advised Fund belongs to the sponsoring organization, it does not require any ongoing administration on the Donor’s part.
Cons of a Donor Advised Fund
Donor Advised Funds have little flexibility.
Money from a Donor Advised Fund can only be given to 501(c)(3) organizations and DAF dollars cannot be given to private foundations.
Donors do not have full control over their Donor Advised Funds.
Although it is rare, the sponsoring organization holding a Donor Advised Fund could deny a donor’s request to grant funds out to a specific organization. Generally this only happens if your Donor Advised Fund sponsor has a political or social leaning that is in opposition to your grant request.
Donor Advised Funds do not have a built-in mechanism for family giving.
Donor Advised Funds do not have a built-in structure to create a board or other family giving group. Donor’s who wish to involve their family or other loved ones in DAF giving will have to create that structure themselves.
What are the pros and cons of a private foundation?
Pros of a private foundation
Private foundations have latitude in the types of investments and grants they make.
In addition to granting money to 501(c)(3) charitable organizations, private foundations can also grant money to individuals, scholarship funds, or international charities. Private foundations can also make mission-aligned investments, below market-rate investments that further the foundation’s charitable purpose.
Private foundations can provide income for family members who work for the foundation.
If family members serve a key role in foundation oversight and granting activities, they may be able to receive “reasonable compensation” from the foundation.
Private foundations have a built-in mechanism for family giving to continue after the initial funder passes away.
Private foundations are often built to endure across generations. Their legal structure can require family members continued involvement after the initial funder(s) pass away.
Cons of a private foundation
Private foundations are required to make public filings.
The assets and granting activities of private foundations are public record through IRS form 990, which limits the amount of privacy around family philanthropy.
Private foundations are expensive and have many annual administration requirements.
Private foundations require an attorney to set up and have ongoing annual tax, legal, and administrative obligations. These ongoing obligations are expensive and time consuming for the Foundation’s board and staff.
Private foundations generally only make sense for donors with $5m or more in charitable assets.
Because of the expense of setting up and operating a foundation, as well as the time commitment required for donors and loved ones, it generally does not make sense to set up a private foundation with assets of less than $5 million.
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What are the rules of Donor Advised Funds?
Contributions to Donor Advised Funds are irrevocable - assets cannot be taken back once gifted.
Donor Advised Funds can only give money to 501(c)(3) organizations. They cannot grant money to 501(c)(4) lobbying organizations, Political Action Committees, individuals, or private non-operating foundations.
A DAF’s sponsoring organization is not required to approve donors’ requests for distributions from their Donor Advised Funds. In practice, this is rarely encountered.
What are the rules of private foundations?
Contributions to private foundations are irrevocable - assets cannot be taken back once gifted.
Private foundations must grant out 5% of their net average investments every year.
All private foundations must file a Form 990 annually with the IRS.
Families may not use their private foundations to enrich themselves or “self-deal.”
Private foundations must be reasonable in the types and amounts of expenses incurred to operate the foundation.
What are the tax benefits of a Donor Advised Fund?
Cash donations to a Donor Advised Fund are generally eligible for an income tax deduction of 60% of your adjusted gross income.
Donations of stock or other appreciated assets to a Donor Advised Fund are generally eligible for a tax deduction of 30% of your adjusted gross income.
Highly-appreciated assets can be transferred into a Donor Advised Fund and then sold, eliminating capital gains tax on your tax return.
What are the tax benefits of a private foundation?
Cash donations to a private foundation are generally eligible for an income tax deduction of 30% of your adjusted gross income.
Donations of stock or other appreciated assets to a private foundation are generally eligible for a tax deduction of 20% of your adjusted gross income.
Highly-appreciated assets can be transferred into a private foundation and then sold, eliminating capital gains tax on your tax return.
How do you set up a Donor Advised Fund?
Identify your preferred sponsoring organization. This could be a custodian like Schwab or Fidelity, a DAF platform like ImpactAssets, or a Community Foundation.
Set up a DAF account with the sponsoring organization. This should be an easy process with minimal paperwork.
Transfer assets or cash into your Donor Advised Fund. Your sponsoring organization should assist with this process.
Start making distributions out to charity from your Donor Advised Fund.
How do you set up a Private Foundation?
Work with an attorney to set your foundation up as a legal entity and apply for tax-exempt status from the IRS.
Establish a foundation board of trustees to help determine how foundation assets are invested, when grants are distributed from the foundation, and the size of the foundation grants.
Fund your foundation with an initial endowment of at least $1 million. Generally, I advise families who have less than $5 million to consider a different charitable giving vehicle.
Start working with your board to make grants out to charity from your foundation.
What are alternatives to Donor Advised Funds or private foundations?
If you’ve read through this post and decided that a DAF or private foundation isn’t right for you, you still have options. You could consider funding a charitable trust, making large gifts of appreciated assets on an annual basis, or making a gift to your local community foundation.
To talk more about the giving vehicle that meets your needs or how to build a plan to formalize your charitable giving, reach out to Katherine to schedule a call to discuss how you can start creating impact with your philanthropic dollars.
Let’s take the next step together
Understanding if a private foundation or Donor Advised Fund is the best way to support philanthropic giving is not easy. Individuals and families can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms You Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a financial planner for inheritors to learn how Sunnybranch can help you set up a charitable giving vehicle that aligns with your goals.
