Clearing the confusion: Debunking myths about DAFs

Partner blog: This blog is in partnership with John T. Keith, senior consultant with Johnson Grossnickle and Associates (JGA), which has been providing authentic strategic and philanthropic consulting services to nonprofit clients since 1994. JGA’s team of senior consultants offers client-focused, highly customized philanthropic consulting services to education, healthcare, arts and culture, faith-based, and community organizations.

Newton’s third law tells us that for every action there is an equal and opposite reaction. Sometimes it seems the same principle applies to big ideas. Every time an idea gains acceptance and popularity, voices rise to question it.

The donor-advised fund (DAF) is no exception.

Recognized by experts as the nation’s fastest-growing philanthropic vehicle, DAFs attract billions of dollars in contributions annually. In 2021, donors contributed a record $72.67 billion into DAFs, according to the National Philanthropic Trust, with overall assets held in DAFs rising to $234 billion. From that pool, charities received $45.74 billion in the form of grants in 2021.

Still, some critics suggest DAFs should be more scrutinized and more heavily regulated.  Which begs the question: Why?

Why DAFs are so popular

While DAFs have been around since the 1930s, they’ve gained in popularity in recent years, in large part because of their simplicity and benefits.

Putting DAFs into play for donors is relatively easy. A financial institution can connect a donor with a sponsoring charity (Ren provides one in the form of Renaissance Charitable Foundation), which then creates a DAF on the donor’s behalf. The donor decides how much to put into the DAF, from a few thousand dollars to millions, and what assets to use to fund the DAF.

These irrevocable gifts qualify as charitable contributions, giving the donor immediate tax benefits and a way to avoid capital gains taxes if they contribute appreciated assets directly to the DAF. A donor can make ongoing contributions to the DAF as desired, receiving tax benefits in the years in which contributions are made.

While the donor no longer owns the assets contributed to the DAF, they can advise how the assets are invested and recommend grants made from the DAF to nonprofit organizations. This power remains with the donor for life and can be passed on to future generations, creating an impact that lasts well into the future.

Certainly, DAFs aren’t going to be the perfect option for every donor. Some high-net-worth individuals might prefer to do their charitable giving through private foundations to maintain greater control over assets and how they are distributed (though DAFs can be an excellent complement to private foundation in many cases). Others might have more immediate objectives, such as creating an income stream from a charitable remainder trust, and others see virtues in different options. Regardless, given DAFs’ popularity and impact, they can’t be ignored as an option for people wanting to make smart charitable contributions.

Why DAFs are good for charities, too

So, we’ve determined that DAFs are growing and that they’re good for donors, but what about their impact on nonprofit organizations? 

To put it succinctly, the impact from DAFs on nonprofits is good.

Not only do DAFs grant billions of dollars each year to charities ($45.74 billion in 2021, as noted above), but they also put a big share of their assets to work for nonprofits and their causes. In fact, in every year on record, DAFs have distributed more than 20% of their value to charity, and in 2021 they hit an all-time high of 27.3%. Compare that to foundations’ annual payout rate, which is only a little above their required 5%.

Despite this high distribution rate, some have suggested that DAFs should have a legally required distribution rate, which would ensure donors don’t “park” money in the funds, gaining tax deductions without being required to distribute money to qualifying charities. We see this as unnecessary, for a couple of reasons.

First, while it’s true DAFs are not required to distribute funds, no one gains anything by withholding charitable distributions. Donors can’t reclaim assets from a DAF or benefit from their growth. As Elizabeth McGuigan Philanthropy Roundtable’s vice president of policy and government affairs, explained in a three-part series examining DAFs, “… every dollar an American puts into a DAF must be directed to a qualified charity and may not be withdrawn for any other use or transferred to a non-charitable account.”

Second, commentators such as McGuigan worry that such regulation might actually inhibit giving, with the 7% payout rate being seen as “a signal that is a ceiling rather than a floor.” Imagine the impact of that: billions of dollars less being made available for charitable work.

Additional benefits

In addition to their simplicity and impact, DAFs deliver a range of benefits for charitably mined individuals and families and the organizations they support. 

One key benefit is that they allow for greater flexibility in giving, especially if a donor wants to claim a charitable tax deduction on a large sum – perhaps to offset a major financial event or considerable capital gain – but is not interested in committing that sum within a tight timeframe. By establishing a DAF and claiming the deduction on the amount contributed to the DAF, the donor creates a pool of funds from which to oversee distributions over time, without pressing deadlines.

Having such a fund can also help to ensure a consistent level of giving in times of economic upheaval. Because the funds already are set aside and cannot be used for anything else, the donor has the capacity to direct distributions to charities and causes they believe in, even if their own cash flow becomes limited.

In fact, a Stanford Law School Policy Lab on donor-advised funds article suggests that DAFs could help to increase the impact of donated funds in times of inflation. The authors note, “… dollars in DAFs are invested in stocks, bonds, and other assets that tend to grow faster than the inflation rate … So the tradeoff posed by delay is not a dollar now versus a dollar later; in most times, it’s a dollar now versus something more than a dollar later.”

DAFs also can provide a resource to donors who fall short of the standard deduction amount. By “bunching” or “bundling” contributions from coming years into one year in a DAF, the donor can exceed the standard deduction level for one year and then use the DAF to support charities as usual in following years.

Finally, DAFs can lighten the administrative burdens that charitable giving can put on donors and their wealth advisors, as the DAF administrator can execute and record distributions, manage charitable-giving records, provide necessary tax documents and deliver other administrative services.

A tool for giving  

As with any financial resource, the choice to use a DAF is a personal one to be made by a donor in conjunction with wealth advisors, tax specialists, and others on their advisory team. In this process, donors balance the opportunities presented by their giving options and make the choice that fits with their objectives. If DAFs prove to be the right solution for them, then they should take advantage of that solution, confident that they are joining a movement that is doing a lot of good … good that can be measured by the billions.

John T. Keith is a senior consultant with Johnson Grossnickle and Associates. Johnson, Grossnickle and Associates (JGA) has been providing authentic strategic and philanthropic consulting services to nonprofit clients since 1994. JGA’s team of senior consultants offers client-focused, highly customized philanthropic consulting services to education, healthcare, arts and culture, faith-based, and community organizations.

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