Charitable planning, like most areas of financial planning, is not one-size-fits-all. Your needs and priorities as a donor may differ from the next donor depending on your overall goals and intentions. We hope this article will help you understand two of the most commonly used charitable planning options for individuals and families: donor-advised funds and private foundations.
While this article is intended to be an introduction to these vehicles, it is a good idea to talk to your lawyer or other trusted advisors about your charitable planning objectives to help determine which option is best suited to your circumstances.
A reference chart following the descriptive sections below offers a side-by-side comparison of a donor-advised fund and a private foundation. The remainder of this article will address each point of comparison in greater detail.
What is a Donor-Advised Fund?
The uses and benefits of the donor-advised fund (DAF) have remained largely unchanged since client advisor George Climer wrote about them in 2016. If anything, they have gained popularity and their use among charitable donors has increased.
A donor-advised fund is an investment account established and funded by a taxpayer to direct distributions in the form of grants to the qualified charities they have selected. A qualified charitable sponsor such as Schwab Charitable, Fidelity Charitable, or a community foundation like Foundation for the Carolinas maintains custody of the account and must approve the grants recommended by the taxpayer.
For tax purposes, you are making a charitable gift in the year in which you contribute to the donor-advised fund, not when distributions are made from the DAF to the end charity. You only get the deduction once! If you are the named advisor for the DAF, you have the authority to determine how the fund’s assets are invested within the account. You will also decide the amount and timing of subsequent grants from the DAF to the charities you have selected (and the custodian has approved). Some people think of their DAF as their “charitable savings account.” Funds are deposited today, allowed to grow, and then distributed to charities in the months or years to come.
You might consider a donor-advised fund if you’re interested in creating a charitable giving vehicle that is efficient, simple, and impactful.
What is a Private Foundation?
A private foundation (PF) is a private charity created, funded, and operated by an individual, a family, or a corporation. There are two common types of private foundations: operating and non-operating foundations. An operating foundation is organized to directly manage or lead a charitable project or business, such as a library or zoo. In this article, we will examine non-operating private foundations, which are typically established to direct gifts to charitable causes.
While private foundations have much in common with donor-advised funds, there are two significant differences: donor control and timeframe. Donors to PFs maintain more control of their contributions than donors to DAFs, and PFs are typically established by donors who are interested in long-term family participation in charitable giving. DAFs usually are not permanent entities. A private foundation is a 501(c)(3) charitable organization that operates under specific IRS rules and requirements. These IRS rules and requirements are perhaps the third most significant difference between PFs and DAFs. The rules and the greater administrative burden required in operating a PF make it more expensive and time-consuming than maintaining a DAF.
Private foundations are powerful giving vehicles, but as mentioned, they can be costly, time-consuming, and administratively burdensome compared to a donor-advised fund.
|
Donor-advised funds |
Private foundations |
| Ability to name successors and create a family legacy |
Y |
Y |
| Minimum funding |
N |
N |
| Growth potential with investment management |
Y |
Y |
| Option to support charities anonymously |
Y |
N |
| Free setup |
Y |
N |
| Donations of non-cash items |
Y |
Y |
| Recordkeeping and reporting responsibility |
The fund sponsor |
Yours / the donor’s |
| Excise tax on investment income |
N |
A % of net investment income (after deductions for expenses and other distributions) |
| Option for “perpetuity” |
Y |
Y |
| Ongoing expenses |
Varies but generally 0.10% – 1% of the assets |
Varies widely |
Income tax deduction*
*Percentage of adjusted gross income (AGI) |
60% for cash
30% for long-term appreciated assets*
*Appreciated assets are generally deductible at fair market value (this applies to both publicly and non-publicly traded assets) |
30% for cash
20% for long-term appreciated assets*
*Appreciated, publicly traded assets are generally deductible at fair market value, while non-publicly traded assets are generally deductible at the lesser of FMV or cost basis |
| Organizations you can support |
IRS-qualified public charities |
Many organizations and individuals, as long as the grant is made for a charitable purpose |
| Annual distribution minimum |
N |
Y |
| Consider this when |
You want a giving solution with low costs and the potential to grow tax-free over time. |
You want to operate a charitable organization and potentially employ a staff, hire investment managers, actively manage grant-making, and sponsor charitable events. |
What is the Same?
Funding Flexibility: When you make gifts to a DAF or a PF, you can choose to contribute a lump sum or you can choose gradual funding over a period of years or even decades. A donor might contribute a large lump sum for tax or other reasons, or alternatively choose to contribute an annual amount that is no greater than the amount they intend to then distribute in the form of grants from the DAF to the ultimate charitable recipients.
Legacy: Leaving a philanthropic legacy may be part of your vision or something you’d like to consider in the future. Both a DAF and a PF can provide a structure for family or legacy giving. With either vehicle, you can create a mission statement, design a succession plan for future advisors, and outline a vision for how the funds should be distributed beyond your lifetime. As mentioned above, it is more common to see long-term generational planning with a private foundation. However, this planning, while somewhat more limited, is also available with a DAF.
Grant-making flexibility: Both DAFs and PFs allow significant flexibility with the timing and amount of grants. The donor can control and invest the charitable assets until the point at which grants to the recipient charitable organizations are made.
Tax Deductions: In most cases, contributions to a DAF or PF are tax-deductible. Tax law changes in 2017 subjected the deduction of charitable gifts to a higher hurdle than in prior years. Still, with strategic bunching (making larger gifts in some taxable years and none in other years), you can maximize the value of the charitable deduction offered. Client Advisor Mary Lou Daly included greater detail about bunching in her 2018 article.
Timing of Deductions: Both a DAF and a PF allow a donor to control the timing of charitable gifts for tax purposes. The donor may make a large gift to one of these vehicles in a particularly high-income year, perhaps after the sale of a business or an IRA has been converted to a Roth IRA.
Timing of Grants: A donor can decouple the timing of a tax deduction from the timing of grants to the recipient charitable organizations. For example, the donor might make a large lump sum contribution to the PF or DAF in 2022, then slowly dole out the grants to charities over the next five or ten years.
Assets for Funding: Contributions to a DAF or PF can be in the form of cash, securities, real estate, business interests, and other assets. Many donors contribute long-term appreciated securities, providing the added tax benefit of not having to pay capital gains tax on those contributed securities.
While you can deduct contributions to either charitable account, the deduction amount may vary, as discussed later in this article under “Tax-Deductibility.”.
Minimum Funding: A donor-advised fund can be established with minimal funding, depending on the charitable fund sponsor. The same is technically true of a private foundation, but most private foundations are funded with larger dollar amounts due to the greater tax and administrative burden. In our opinion, $500,000 would be the minimum amount to justify setting up a private foundation, even if the donor plans to handle the administrative work. If third-party professionals will be employed to handle the administrative burden, then the minimum funding amount should be north of $2 million.
Investment Management: Both vehicles offer attractive options and flexibility for investment management. With a DAF, the donor can choose from a menu of investment options provided by the charitable sponsor or appoint a third-party investment manager to construct a portfolio. Depending on the timeline and intentions, the donor can elect to invest conservatively or aggressively. A private foundation provides even more investment flexibility; the assets of the foundation can be invested in a wide range of assets, including stocks, bonds, real estate, operating businesses, and other assets.
Types of Contributions: Both a DAF and a PF can accept contributions of many kinds of assets. However, suppose you are considering a gift of assets other than cash or publicly traded securities (for example, interests in a closely held business, real estate, collectibles). In that case, the preferred vehicle will heavily depend on the specifics of the asset being transferred. Your attorney and other advisors should help navigate the contribution of complex assets to any charitable vehicle to ensure you receive the most favorable tax treatment.
Tax on Growth: The growth on assets contributed to a DAF is tax-free. Likewise, the growth on assets contributed to a PF is generally tax-free. This is a great way to extend your charitable impact. It should be noted, however, that the net investment income and any realized gains in the PF may be subject to an excise tax of 1.39% if deductions are not sufficient to offset these income items. Under current law, there is no tax (and no separate tax return) on the investment income or gains in the DAF. Private foundations must file an annual tax return.
Lifespan: Both giving arrangements will ultimately terminate when the funds are exhausted, but there are options to consider before that happens.
With a DAF, you can typically name a successor advisor to take over this responsibility at your passing. If no successor is named, the balance in the DAF is generally added to the general giving fund of the charitable sponsor. Alternatively, you can name final charitable beneficiaries to receive the remaining assets in the fund at your death if you do not want to name successor advisors and you do not want the funds to become part of the general fund of the charitable sponsor.
In theory, a PF will exist in perpetuity. The board of directors or trustees must vote for successor directors or officers. In practice, there may not be anyone who wants to continue the foundation after the death of the original donor. When that happens, the PF can be dissolved, and all remaining assets will be distributed to a specific charitable organization(s) or a DAF.
What is Different?
Anonymity: DAFs can provide more privacy than a PF. The name of a donor-advised fund is the name you specify when you establish the account. The name does not have to include any part of your personal name and can be completely made up. This is the name that will appear with the grants distributed to each charitable organization. The recipient of the grant will not be able to determine that the gift came from you unless you notify the organization. For an additional layer of privacy, you can also mark the gift as “anonymous” when submitting the information to make the distribution.
Despite their name, private foundations are not private and offer little confidentiality. A PF’s annual tax return will disclose the key employees and officers of the foundation. The return also includes information such as the grantees and grant amounts, foundation balance sheet and investments, and management expenses. This tax return is publicly available; any curious individual can find the information filed on the tax return, including employees and officers, some of whom will likely be you and/or your family members. (Note: the term “private foundation” is not in reference to any secrecy or anonymity as the term “private” might imply. Rather, the term private foundation is used to differentiate it in the IRS Code from a public charity, which is subject to different rules for tax purposes.)
A workaround is available for donors interested in a private foundation but desiring additional privacy. A DAF is an eligible recipient of funds from a PF. When a PF contributes to a DAF, only the DAF name will be listed on the public PF records as a grant recipient. Any subsequent distributions from the DAF to charitable organizations will not be tracked back to the PF.
Set-up: As mentioned in George Climer’s article, a DAF is opened with a qualified charitable sponsor such as Schwab Charitable, Fidelity Charitable, or a community foundation like Foundation for the Carolinas. The paperwork is limited to the account opening paperwork required by the charitable sponsor. There is no separate legal filing requirement with the state. With most sponsor arrangements, a third-party investment advisor can be named to manage the DAF account.
A private foundation is more involved. The PF must first be established as a legal entity with its own tax ID number. It will be governed either by a trust agreement or by articles of incorporation and bylaws. We recommend hiring an accountant or attorney skilled in establishing private foundations to ensure the appropriate paperwork is completed and filed. Once the foundation is formed, an investment account can be established at any major financial institution. The donor typically becomes the trustee or director of the PF and maintains the ability to direct investments or hire an investment advisor.
Recordkeeping: The sponsor organization for the donor-advised fund is responsible for all recordkeeping, administrative reporting, and other functions required by the IRS. Typically, the donor will also have online access to the sponsor and/or investment advisor’s portal to view balances, activity, investments, and historical grants. Some sponsor organizations will also offer additional support services depending on the level of assets in the account.
With a private foundation, the recordkeeping and all administration is the responsibility of the board, trustee, or employees of the private foundation. Some duties can be outsourced, but none should be overlooked. The foundation is responsible for filing an annual tax return with the IRS, keeping accurate records of all contributions and grants made, sending acknowledgments to donors (if applicable), and adhering to IRS rules regarding conflicts of interest, employees, and other matters.
Ongoing Expenses: Administrative costs are usually higher for private foundations. Typically, the DAF plan sponsor will charge an administrative fee based on the assets in the account (or assets under management). This may range from 0.10% (10 basis points) up to 1% of assets depending on the total assets; the higher the balance in the account, the lower the fee as a percentage. Remember, the DAF sponsor is responsible for all the recordkeeping and administration of the DAF that you would have if you had utilized a PF instead. The DAF administrative fee covers the expenses of operating a donor-advised fund account, such as online donor services, phone support, grant due diligence and administration, tax filings, annual account summaries, and communications.
In addition to the administrative sponsor fee, there will be a fee for the investment of the funds. This fee will also be presented as a percentage of the assets under management and can vary significantly. You can choose to use the sponsor’s investment pools or, if specified minimums are met, you can have your DAF invested by your investment advisor.
In either case, total administrative and investment fees should be less than 2%, and ideally less than 1%, of the total fund annually.
The costs for administering a private foundation are more difficult to define but we’ll include the costs to consider here. Startup costs ($0 for a DAF) can be thousands of dollars for a PF. Some service providers specialize in starting foundations, or you can use an attorney who specializes in trusts and nonprofits to help with the formation. Either way, the costs for these services can range from $4,000 to more than $25,000.
The private foundation will also have ongoing operating expenses like accounting fees for filing the annual tax return, investment advisor fees, and the cost of any in-house staff. Depending on the size of the foundation, these fees can vary greatly. As you can imagine, the administrative costs for running The Bill and Melinda Gates Foundation or the Ford Foundation will be far higher than the costs of running a small family foundation with $3 million in assets and limited annual grants.
Depending on your long-term objectives, you should carefully weigh these costs to determine which vehicle best matches your charitable goals.
Tax Deductibility: The deduction for making contributions to a DAF can be up to 60% of your adjusted gross income (AGI) each year for cash* and 30% of AGI for contributions of long-term capital gain property (such as appreciated securities).
Deductibility of contributions to private non-operating foundations (most family foundations) is generally limited to 30% of AGI (20% for long-term capital gains property).
There are many nuances to the deductibility of charitable contributions, particularly with regard to the type of assets and specific type of foundation. Be sure to work closely with your accountant before making any charitable contributions to ensure you receive the greatest deduction possible. If you make charitable contributions in a taxable year greater than the allowable deductible limit, you can carry forward the amount not allowed and use it as a deduction on future returns for up to five years.
*Note: The 60% limit on cash contributions will revert back to the prior 50% level after 2025, when the current tax law is scheduled to sunset to 2018 levels, unless new law is passed by Congress.
Types of Grants: Grants from DAFs are limited to contributions to eligible 501(c)(3) public charities.
A private foundation can make contributions to public charities as well as establish its own grant-making function to make charitable contributions directly to individuals or other non-public organizations. The PF is responsible for all due diligence and legal compliance related to grant-making activity. A grant-making foundation can quickly become an operating foundation, which can involve many additional complexities beyond this article’s scope. Be sure to consult your advisors for additional information if it is of interest to you.
Annual Distributions: There is no annual requirement for grant distributions from a DAF. In some years, you may decide to forego making any grants and in other years you may decide to give the full balance, or anything in between.
In contrast, by law, private foundations are required to disburse 5% of their holdings annually to charity, regardless of the donor’s willingness and irrespective of market conditions. Some operational expenses mentioned earlier can count toward this 5% minimum. For any year in which this 5% minimum is not met, the IRS assesses a penalty to the foundation on undistributed amounts.
Using Both
You might find ease in knowing you don’t have to choose between a donor-advised fund and a private foundation. You might start with one and add the second later; the two vehicles complement each other in many ways. You may decide to establish a private foundation but occasionally direct grants from the foundation to the DAF in order to make anonymous gifts to a specific organization. You may also choose to establish a DAF alongside a PF to leverage some of the due diligence and in-house expertise available at the DAF sponsor organization. Additionally, you may decide to fund a DAF in years in which you want to contribute more than the AGI limits placed on the PF. If you have significant non-cash, non-publicly traded assets to contribute (for example, real estate or closely held business interests), you may want to add those to the DAF in order to deduct the fair market value of the long-term appreciated assets. Your deduction for these same assets in a PF may be limited to the cost basis of those assets.
And lastly, as mentioned above under “Lifespan,” you can direct final assets from a private foundation to a donor-advised fund to terminate the foundation, reduce the administrative burden and expenses, and extend the time to fully deplete the remaining assets from the DAF.
As with all planning considerations, we encourage you to carefully review your options and consult your advisors to ensure you make the best decision for your circumstances.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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September 26, 2022Charitable planning, like most areas of financial planning, is not one-size-fits-all. Your needs and priorities as a donor may differ from the next donor depending on your overall goals and intentions. We hope this article will help you understand two of the most commonly used charitable planning options for individuals and families: donor-advised funds and private foundations.
While this article is intended to be an introduction to these vehicles, it is a good idea to talk to your lawyer or other trusted advisors about your charitable planning objectives to help determine which option is best suited to your circumstances.
A reference chart following the descriptive sections below offers a side-by-side comparison of a donor-advised fund and a private foundation. The remainder of this article will address each point of comparison in greater detail.
What is a Donor-Advised Fund?
The uses and benefits of the donor-advised fund (DAF) have remained largely unchanged since client advisor George Climer wrote about them in 2016. If anything, they have gained popularity and their use among charitable donors has increased.
A donor-advised fund is an investment account established and funded by a taxpayer to direct distributions in the form of grants to the qualified charities they have selected. A qualified charitable sponsor such as Schwab Charitable, Fidelity Charitable, or a community foundation like Foundation for the Carolinas maintains custody of the account and must approve the grants recommended by the taxpayer.
For tax purposes, you are making a charitable gift in the year in which you contribute to the donor-advised fund, not when distributions are made from the DAF to the end charity. You only get the deduction once! If you are the named advisor for the DAF, you have the authority to determine how the fund’s assets are invested within the account. You will also decide the amount and timing of subsequent grants from the DAF to the charities you have selected (and the custodian has approved). Some people think of their DAF as their “charitable savings account.” Funds are deposited today, allowed to grow, and then distributed to charities in the months or years to come.
You might consider a donor-advised fund if you’re interested in creating a charitable giving vehicle that is efficient, simple, and impactful.
What is a Private Foundation?
A private foundation (PF) is a private charity created, funded, and operated by an individual, a family, or a corporation. There are two common types of private foundations: operating and non-operating foundations. An operating foundation is organized to directly manage or lead a charitable project or business, such as a library or zoo. In this article, we will examine non-operating private foundations, which are typically established to direct gifts to charitable causes.
While private foundations have much in common with donor-advised funds, there are two significant differences: donor control and timeframe. Donors to PFs maintain more control of their contributions than donors to DAFs, and PFs are typically established by donors who are interested in long-term family participation in charitable giving. DAFs usually are not permanent entities. A private foundation is a 501(c)(3) charitable organization that operates under specific IRS rules and requirements. These IRS rules and requirements are perhaps the third most significant difference between PFs and DAFs. The rules and the greater administrative burden required in operating a PF make it more expensive and time-consuming than maintaining a DAF.
Private foundations are powerful giving vehicles, but as mentioned, they can be costly, time-consuming, and administratively burdensome compared to a donor-advised fund.
*Percentage of adjusted gross income (AGI)
30% for long-term appreciated assets*
*Appreciated assets are generally deductible at fair market value (this applies to both publicly and non-publicly traded assets)
20% for long-term appreciated assets*
*Appreciated, publicly traded assets are generally deductible at fair market value, while non-publicly traded assets are generally deductible at the lesser of FMV or cost basis
What is the Same?
Funding Flexibility: When you make gifts to a DAF or a PF, you can choose to contribute a lump sum or you can choose gradual funding over a period of years or even decades. A donor might contribute a large lump sum for tax or other reasons, or alternatively choose to contribute an annual amount that is no greater than the amount they intend to then distribute in the form of grants from the DAF to the ultimate charitable recipients.
Legacy: Leaving a philanthropic legacy may be part of your vision or something you’d like to consider in the future. Both a DAF and a PF can provide a structure for family or legacy giving. With either vehicle, you can create a mission statement, design a succession plan for future advisors, and outline a vision for how the funds should be distributed beyond your lifetime. As mentioned above, it is more common to see long-term generational planning with a private foundation. However, this planning, while somewhat more limited, is also available with a DAF.
Grant-making flexibility: Both DAFs and PFs allow significant flexibility with the timing and amount of grants. The donor can control and invest the charitable assets until the point at which grants to the recipient charitable organizations are made.
Tax Deductions: In most cases, contributions to a DAF or PF are tax-deductible. Tax law changes in 2017 subjected the deduction of charitable gifts to a higher hurdle than in prior years. Still, with strategic bunching (making larger gifts in some taxable years and none in other years), you can maximize the value of the charitable deduction offered. Client Advisor Mary Lou Daly included greater detail about bunching in her 2018 article.
Timing of Deductions: Both a DAF and a PF allow a donor to control the timing of charitable gifts for tax purposes. The donor may make a large gift to one of these vehicles in a particularly high-income year, perhaps after the sale of a business or an IRA has been converted to a Roth IRA.
Timing of Grants: A donor can decouple the timing of a tax deduction from the timing of grants to the recipient charitable organizations. For example, the donor might make a large lump sum contribution to the PF or DAF in 2022, then slowly dole out the grants to charities over the next five or ten years.
Assets for Funding: Contributions to a DAF or PF can be in the form of cash, securities, real estate, business interests, and other assets. Many donors contribute long-term appreciated securities, providing the added tax benefit of not having to pay capital gains tax on those contributed securities.
While you can deduct contributions to either charitable account, the deduction amount may vary, as discussed later in this article under “Tax-Deductibility.”.
Minimum Funding: A donor-advised fund can be established with minimal funding, depending on the charitable fund sponsor. The same is technically true of a private foundation, but most private foundations are funded with larger dollar amounts due to the greater tax and administrative burden. In our opinion, $500,000 would be the minimum amount to justify setting up a private foundation, even if the donor plans to handle the administrative work. If third-party professionals will be employed to handle the administrative burden, then the minimum funding amount should be north of $2 million.
Investment Management: Both vehicles offer attractive options and flexibility for investment management. With a DAF, the donor can choose from a menu of investment options provided by the charitable sponsor or appoint a third-party investment manager to construct a portfolio. Depending on the timeline and intentions, the donor can elect to invest conservatively or aggressively. A private foundation provides even more investment flexibility; the assets of the foundation can be invested in a wide range of assets, including stocks, bonds, real estate, operating businesses, and other assets.
Types of Contributions: Both a DAF and a PF can accept contributions of many kinds of assets. However, suppose you are considering a gift of assets other than cash or publicly traded securities (for example, interests in a closely held business, real estate, collectibles). In that case, the preferred vehicle will heavily depend on the specifics of the asset being transferred. Your attorney and other advisors should help navigate the contribution of complex assets to any charitable vehicle to ensure you receive the most favorable tax treatment.
Tax on Growth: The growth on assets contributed to a DAF is tax-free. Likewise, the growth on assets contributed to a PF is generally tax-free. This is a great way to extend your charitable impact. It should be noted, however, that the net investment income and any realized gains in the PF may be subject to an excise tax of 1.39% if deductions are not sufficient to offset these income items. Under current law, there is no tax (and no separate tax return) on the investment income or gains in the DAF. Private foundations must file an annual tax return.
Lifespan: Both giving arrangements will ultimately terminate when the funds are exhausted, but there are options to consider before that happens.
With a DAF, you can typically name a successor advisor to take over this responsibility at your passing. If no successor is named, the balance in the DAF is generally added to the general giving fund of the charitable sponsor. Alternatively, you can name final charitable beneficiaries to receive the remaining assets in the fund at your death if you do not want to name successor advisors and you do not want the funds to become part of the general fund of the charitable sponsor.
In theory, a PF will exist in perpetuity. The board of directors or trustees must vote for successor directors or officers. In practice, there may not be anyone who wants to continue the foundation after the death of the original donor. When that happens, the PF can be dissolved, and all remaining assets will be distributed to a specific charitable organization(s) or a DAF.
What is Different?
Anonymity: DAFs can provide more privacy than a PF. The name of a donor-advised fund is the name you specify when you establish the account. The name does not have to include any part of your personal name and can be completely made up. This is the name that will appear with the grants distributed to each charitable organization. The recipient of the grant will not be able to determine that the gift came from you unless you notify the organization. For an additional layer of privacy, you can also mark the gift as “anonymous” when submitting the information to make the distribution.
Despite their name, private foundations are not private and offer little confidentiality. A PF’s annual tax return will disclose the key employees and officers of the foundation. The return also includes information such as the grantees and grant amounts, foundation balance sheet and investments, and management expenses. This tax return is publicly available; any curious individual can find the information filed on the tax return, including employees and officers, some of whom will likely be you and/or your family members. (Note: the term “private foundation” is not in reference to any secrecy or anonymity as the term “private” might imply. Rather, the term private foundation is used to differentiate it in the IRS Code from a public charity, which is subject to different rules for tax purposes.)
A workaround is available for donors interested in a private foundation but desiring additional privacy. A DAF is an eligible recipient of funds from a PF. When a PF contributes to a DAF, only the DAF name will be listed on the public PF records as a grant recipient. Any subsequent distributions from the DAF to charitable organizations will not be tracked back to the PF.
Set-up: As mentioned in George Climer’s article, a DAF is opened with a qualified charitable sponsor such as Schwab Charitable, Fidelity Charitable, or a community foundation like Foundation for the Carolinas. The paperwork is limited to the account opening paperwork required by the charitable sponsor. There is no separate legal filing requirement with the state. With most sponsor arrangements, a third-party investment advisor can be named to manage the DAF account.
A private foundation is more involved. The PF must first be established as a legal entity with its own tax ID number. It will be governed either by a trust agreement or by articles of incorporation and bylaws. We recommend hiring an accountant or attorney skilled in establishing private foundations to ensure the appropriate paperwork is completed and filed. Once the foundation is formed, an investment account can be established at any major financial institution. The donor typically becomes the trustee or director of the PF and maintains the ability to direct investments or hire an investment advisor.
Recordkeeping: The sponsor organization for the donor-advised fund is responsible for all recordkeeping, administrative reporting, and other functions required by the IRS. Typically, the donor will also have online access to the sponsor and/or investment advisor’s portal to view balances, activity, investments, and historical grants. Some sponsor organizations will also offer additional support services depending on the level of assets in the account.
With a private foundation, the recordkeeping and all administration is the responsibility of the board, trustee, or employees of the private foundation. Some duties can be outsourced, but none should be overlooked. The foundation is responsible for filing an annual tax return with the IRS, keeping accurate records of all contributions and grants made, sending acknowledgments to donors (if applicable), and adhering to IRS rules regarding conflicts of interest, employees, and other matters.
Ongoing Expenses: Administrative costs are usually higher for private foundations. Typically, the DAF plan sponsor will charge an administrative fee based on the assets in the account (or assets under management). This may range from 0.10% (10 basis points) up to 1% of assets depending on the total assets; the higher the balance in the account, the lower the fee as a percentage. Remember, the DAF sponsor is responsible for all the recordkeeping and administration of the DAF that you would have if you had utilized a PF instead. The DAF administrative fee covers the expenses of operating a donor-advised fund account, such as online donor services, phone support, grant due diligence and administration, tax filings, annual account summaries, and communications.
In addition to the administrative sponsor fee, there will be a fee for the investment of the funds. This fee will also be presented as a percentage of the assets under management and can vary significantly. You can choose to use the sponsor’s investment pools or, if specified minimums are met, you can have your DAF invested by your investment advisor.
In either case, total administrative and investment fees should be less than 2%, and ideally less than 1%, of the total fund annually.
The costs for administering a private foundation are more difficult to define but we’ll include the costs to consider here. Startup costs ($0 for a DAF) can be thousands of dollars for a PF. Some service providers specialize in starting foundations, or you can use an attorney who specializes in trusts and nonprofits to help with the formation. Either way, the costs for these services can range from $4,000 to more than $25,000.
The private foundation will also have ongoing operating expenses like accounting fees for filing the annual tax return, investment advisor fees, and the cost of any in-house staff. Depending on the size of the foundation, these fees can vary greatly. As you can imagine, the administrative costs for running The Bill and Melinda Gates Foundation or the Ford Foundation will be far higher than the costs of running a small family foundation with $3 million in assets and limited annual grants.
Depending on your long-term objectives, you should carefully weigh these costs to determine which vehicle best matches your charitable goals.
Tax Deductibility: The deduction for making contributions to a DAF can be up to 60% of your adjusted gross income (AGI) each year for cash* and 30% of AGI for contributions of long-term capital gain property (such as appreciated securities).
Deductibility of contributions to private non-operating foundations (most family foundations) is generally limited to 30% of AGI (20% for long-term capital gains property).
There are many nuances to the deductibility of charitable contributions, particularly with regard to the type of assets and specific type of foundation. Be sure to work closely with your accountant before making any charitable contributions to ensure you receive the greatest deduction possible. If you make charitable contributions in a taxable year greater than the allowable deductible limit, you can carry forward the amount not allowed and use it as a deduction on future returns for up to five years.
*Note: The 60% limit on cash contributions will revert back to the prior 50% level after 2025, when the current tax law is scheduled to sunset to 2018 levels, unless new law is passed by Congress.
Types of Grants: Grants from DAFs are limited to contributions to eligible 501(c)(3) public charities.
A private foundation can make contributions to public charities as well as establish its own grant-making function to make charitable contributions directly to individuals or other non-public organizations. The PF is responsible for all due diligence and legal compliance related to grant-making activity. A grant-making foundation can quickly become an operating foundation, which can involve many additional complexities beyond this article’s scope. Be sure to consult your advisors for additional information if it is of interest to you.
Annual Distributions: There is no annual requirement for grant distributions from a DAF. In some years, you may decide to forego making any grants and in other years you may decide to give the full balance, or anything in between.
In contrast, by law, private foundations are required to disburse 5% of their holdings annually to charity, regardless of the donor’s willingness and irrespective of market conditions. Some operational expenses mentioned earlier can count toward this 5% minimum. For any year in which this 5% minimum is not met, the IRS assesses a penalty to the foundation on undistributed amounts.
Using Both
You might find ease in knowing you don’t have to choose between a donor-advised fund and a private foundation. You might start with one and add the second later; the two vehicles complement each other in many ways. You may decide to establish a private foundation but occasionally direct grants from the foundation to the DAF in order to make anonymous gifts to a specific organization. You may also choose to establish a DAF alongside a PF to leverage some of the due diligence and in-house expertise available at the DAF sponsor organization. Additionally, you may decide to fund a DAF in years in which you want to contribute more than the AGI limits placed on the PF. If you have significant non-cash, non-publicly traded assets to contribute (for example, real estate or closely held business interests), you may want to add those to the DAF in order to deduct the fair market value of the long-term appreciated assets. Your deduction for these same assets in a PF may be limited to the cost basis of those assets.
And lastly, as mentioned above under “Lifespan,” you can direct final assets from a private foundation to a donor-advised fund to terminate the foundation, reduce the administrative burden and expenses, and extend the time to fully deplete the remaining assets from the DAF.
As with all planning considerations, we encourage you to carefully review your options and consult your advisors to ensure you make the best decision for your circumstances.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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