The Great DAF Debate: Timing of payouts continues to spark discussion

March 13, 2015       Mark Hrywna      

Hundreds of millions of dollars have been pouring into donor-advised funds (DAF) in recent years. The question for some observers of the charitable world, however, is whether enough has been making its way to the coffers of charities.

In the last two years alone, the Silicon Valley Community Foundation (SVCF) has seen its assets grow incredibly thanks to nearly $2 billion in gifts of appreciated stock. Those donations, however, are not immediately going to charities or even into SVCF’s endowment. The gifts were directed to individual DAFs, used at the discretion of individuals alone, with some advice from the foundation.

DAFs of all kinds have enjoyed tremendous growth since the resurgence of the stock market and the burgeoning economy. The total number of DAFS in 2013, the most recent fiscal year available, topped 217,000, up almost 6 percent over 2012 according to the 2014 Donor-Advised Fund Report by the National Philanthropic Trust. Contributions last year neared $17.3 billion, 23.5 percent more than the previous year, and 84 percent higher than three years ago, and 86 percent higher than in 2008. The value of grants was up 12.5 percent to almost $10 billion last year, up more than third from 2008 and 2010, according to NPT.

While some applaud that kind of meteoric growth in charitable contributions, others are worried that it’s not going directly to charities, or that it might sit in DAF accounts.

Nonprofits are “grinding their teeth, feeling uncomfortable with the explosion of DAFs,” said Al Cantor, who started his own consulting firm several years ago after 30 years as an executive director and chief development officer, including at the New Hampshire Charitable Foundation. Charities are seeing some of their biggest donors – who had previously given directly to them – giving to DAFs and not seeing the funds distributed to charity, he said.

Proponents of donor-advised funds point to payout rates that are significantly higher than the required 5-percent distribution by private foundations. According to data compiled by NPT, each year since 2007 has seen payout rates of better than 20 percent by DAFs.

When doing feasibility studies for organizations launching major campaigns, however, Cantor said he’s seen evidence of DAFs not distributing grants. But he has no details of how many funds or how many people might be sitting on money because community foundations, like SVCF, do not have to share that information. “They don’t have to tell us and they choose not to tell us,” he said, adding that distribution averages can be misleading. “If they seriously think no one is sitting on money, they should show us.”

Emmet Carson sees DAFs as a way for donors to even out their philanthropy over a lifetime. “Farmers store grains for a reason,” said Carson, president and CEO of SVCF. Donor-advised funds are not set up to be spent by someone else’s determination of the time frame. “Each individual gets to determine what’s important to them,” he said.

“What is the value of creating a fund that you never give away the resources? The only value you have in creating it is the joy in giving out grants. To get a deduction, and never grant out, that’s not value. It’s not consistent with the profile of our donors,” he said.

The foundation has a policy of contacting donors when there’s been no payout in two years. “But it’s not activated because people want to give, so it’s counter-intuitive to the experiences of people who are excited to give,” Carson said. Of the 158 DAFs with balances of $1 million or more, SVCF said 7 (4 percent) made no grants in the last two years. SVCF had a total of 1,047 DAFs at the end of 2014, excluding corporate advised funds. The foundation awarded $474 million in grants, including $274 million from DAFs. On a fund-by-fund basis, the average payout of funds with balances of $1 million or more was almost 16 percent. Total assets under management some $6.5 billion, compared to $2 billion just a few years ago.

Carson views a recent shift in perspective as one reason behind the growth in DAFs. Going back 10 to 20 years, there was a greater interest in people creating private foundations with their own staff and thinking of their legacy that way. An increasing number of donors who have looked at that vehicle do not find it to be the most efficient way to get engaged in institutions, he said.

DAFs that don’t distribute funds enjoy tax-free growth, which provides tremendous financial benefit, said Ray Madoff, a professor at Boston College Law School in Newton, Mass. “This is the question of endowments: To what extent do we want to set aside funds as opposed to encourage money being currently spent,” she said.

Madoff has suggested establishing some period of time in which money contributed to DAFs must be spent. “If you think payout is important — and I believe you should — what’s the objection to having payout after a reasonable time? The reason we have rules is for people who might not otherwise do it,” she said. Those who tout payout rates should encourage payout and not be opposed to payout within a reasonable timeframe.

“Saving money to spend 100 years from now is not something we should be encouraging given the expense of the charitable contribution,” Madoff said. If a donor gives $10 million of appreciated assets to a DAF, that taxpayer is potentially saving more than $6 million in capital gains and income taxes, before even including any savings on estate taxes. “That’s costing the rest of us over $6 million. The public should be knowing it’s going to get something for that $6 million contribution, not simply having $10 million set aside to be spent in some undetermined future at the whim of a donor,” she said.

Given the rise of DAFs, there is increased interest in this topic, so much that a conference is planned this fall. Boston College has established the Forum on Philanthropy and the Public Good, which aims to provide nonpartisan, high-quality research for the purposes of addressing issues in philan­thropy and the public good.

“The question we need to think about is: Should all sponsoring organizations should be treated the same. We have a situation where we have different types of sponsoring organization, and it’s not clear that they should all be treated the same,” she said. DAFs first were created by community foundations some 80 years ago but financial firms got into the act after Fidelity created the Charitable Gift Fund almost 25 years ago, which launched the tremendous growth seen in the commercial world.

Make no mistake, Cantor believes DAFs are a good vehicle for folks who have a liquidity event, such as selling a business and suddenly have money to give away. He doesn’t like the idea that there is no payout requirement. At the same time, he’s opposed to instituting a 5-percent payout minimum because then what’s meant to be a minimum becomes a de facto maximum, in the same way 5 percent became standard for private foundations after the Tax Reform Act of 1969 required it as a minimum.

He supports setting a horizon on when money should exit a DAF. “Let’s come up with something, maybe longer than five or seven years. As a public policy matter, we should get as much of it out to the community as we can, “ Cantor said. Organizations and the people they serve need the money now,” he said.

A donor to a DAF is “is getting the same charitable benefit as giving to soup kitchen, to a Boys and Girls Club, or to a museum so it can stay open Tuesdays. Money ought to go to charity. Is that too much to ask?”

Howard Husock, vice president for policy research at the Manhattan Institute, said the only serious, positive trend in giving has been the growth of DAFs.

In a research paper due out next month, Husock wrote the underappreciated aspect of DAFs is that balances can grow substantially. “These are in effect mini-endowments and min-foundations blossoming widely,” he said, adding that the paper was entirely self-initiated and did not receive any financial support from any DAFs.

If funds are not transferred within five years, they could become substantially more well-endowed, Husock said. Conservatively estimating that these balances grow some 6 percent annually, his paper forecasts DAFs pushing charitable giving higher.

Financial advisors could be motivated to direct donations away from charities and toward DAFs and let those assets grow. “I understand capitalism and respect capital forces but what people are brushing under rug is that there’s a profit motive for everyone in the financial field to promote DAFs,” Cantor said. It used to be that a client who wanted to give money could direct their advisor to transfer appreciated stock to a charity. Instead, that advisor can direct donors to give to a DAF, where the advisor would still get a management fee. “There is a lot of money being made by this but a lot of need in the community.”

SVCF is probably the only community foundation that could rival the scale of commercial firms like Vanguard, Fidelity or Schwab. “Is that a tax dodge? Wealthy people have always set up private foundations…so this is another version of that, which one can argue has lower administrative costs and aligns with community advice and priorities,” Husock said.

Most charities don’t have a legal team and are not able to accept appreciated assets, such as art. For that reason, DAFs such as Fidelity or Vanguard are good for valuing and accepting appreciated assets for tax purposes, Husock said. DAFs are the “democratizing of private foundations, he said, adding that average balances are relatively modest and reflects that.

DAFs provide a very tax efficient way to giving appreciated, nonpublicly traded assets and to increase a donor’s impact, according to Amy Danforth, president of Fidelity Charitable Gift Fund. More than half of contributions through Fidelity have come in the form of appreciated assets while more than 71 percent of contributions to Schwab Charitable Gift Fund have been in that form.

Danforth expects donations of complex assets will continue to grow because awareness is increasing and aging Baby Boomers are transitioning privately-held businesses and DAFs are a great way to plan charitable contributions. The general growth in things like private equity and other nonpublicly traded assets also are becoming more aware of being used for charity.

People tend to turn to DAFs when basic financial needs of housing, college, retirement planning, general saving accounts are met, Danforth said. The average age of opening an account at about 62, with 28 percent of new accounts opened in the $5,000 to $10,000 range and 60 percent with less than $25,000. Donors seem to be prefunding their giving for retirement, when they’ve stopped earning and wouldn’t be able to fund charities, Danforth said, but some people are uncomfortable with the separation of the timing of the tax deduction and the timing of the gift to charity. “We don’t see this as a problem. Our donors are incredibly active, giving while living,” she said.

Fidelity’s granting ratio is more than 20 percent over its history, Danforth said, bringing in some $30 billion in contributions while distributing about $19 billion.

“Having a planned giving vehicle, it allows them to have a longer term plan for giving instead of transactional,” she said. “Being planful and strategic has actually increased giving. Timing is within their control but we see very active grantmaking,” she said. Contributions typically go out within 10 years, according to Danforth, so if a donor contributed in 2004, that money was likely to go out by 2014.

Another advantage to DAFs that once people realize they can open an account, they can view their account along with their other investments, bank accounts, in one view, making it a simpler way to manage giving, said Kim Laughton, president of Schwab Charitable in San Francisco. Many charities not in a position – especially small local charities – to easily accept shares of stock, she said.

Things continue to grow but all metrics are growing, not just contributions but assets and Schwab expects to grant out $1 billion this year, Laughton said.

There are a few high-profile DAFs and very high profile foundations set up in recent years but Laughton said Schwab has lots of accounts ranging from $5,000 to $10,000. “Rather than checks and credit cards, people are donating appreciated stock or cash and just granting it out in the same year,” Laughton said. “It’s not just a tool for the affluent,” she said.

After a 10-year period, Schwab clients have granted out 75 percent of assets, according to Laughton, and national provides typically are granting about an average of 20 percent per year.

For decades, it was difficult to get anyone to understand what a donor-advised fund was, how it operates or what it does, Carson said. “Now that we have some broad understanding and people are actually using it, people ask, what a minute, what’s going on,” he said.

“We are seeing a renaissance in American philanthropy where literally thousands of people are becoming engaged in philanthropy through donor-advised funds,” Carson said. “We ought to celebrate that as a nation.”