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Effective Charitable Planning: Donor-Advised Funds vs. Private Foundations
By: Nicholas Breit, CFA, CFP®
Senior Consultant, The Wealth Office™
Charitably inclined individuals have a number of giving strategies and vehicles to choose from to accomplish their philanthropic goals. Traditionally, individuals might have given cash or appreciated securities directly to a charitable organization; in recent years, however, donors have increasingly favored using donor-advised funds (DAFs) and private foundations (or a combination of both) for their charitable giving.  

Both donor-advised funds and private foundations present their own distinct advantages and disadvantages. Consequently, donors must factor in their own personal circumstances to determine which vehicle (or combination of both) best suits their objectives.  

Donor-Advised Funds
Donor-advised funds can serve as a practical giving solution for most individuals given the low minimums to establish a charitable account. These minimums often fall as low as $5,000 to $10,000.  

The Basics
• The donor makes an irrevocable gift to the fund and receives an immediate charitable tax deduction.
• The donor chooses among a list of investment options to invest and grow the balance of their charitable fund. Investment expenses vary based on the investments chosen, but typically range from 0.02% for a passive index option to 1.00% for an actively-managed investment blend/pool. The sponsor may allow full investment customization outside the preset list of investment options for larger account balances (generally $250k and above).
• The donor recommends the fund sponsor to make charitable grants.  

Advantages
• No start-up expenses
• Low initial minimum to open an account
• Low ongoing maintenance/administrative expenses
• No annual distribution requirements
• No annual filing requirements
• Charitable account grows tax-free
• Gifts/grants can be made publicly or anonymously 
• Gifts/grants can be made in small increments (generally as little as $50 or $100)
• Higher Adjusted Gross Income (AGI) deduction limits for charitable contributions (relative to private foundations)

As a result of these unique features, donor-advised funds have unsurprisingly surged in popularity over the past several years.
Disadvantages
Donor-advised funds do have several limitations which might make a more compelling case for a private foundation:
• DAFs may or may not allow the donor to name a successor or successors, which could jeopardize the longevity of the charitable fund.
• DAFs do not allow for compensating board members/staff.
• DAFs do not allow for contributions to a foreign charity (unless the foreign charity has 501(c)(3) status).
• DAFs do not allow the donor to set up a scholarship program.
• DAFs may not be best suited (relative to a private foundation) for raising outside contributions for a specific cause.
• The sponsor of the DAF retains control over allowing the donor’s requests to make charitable grants. Practically speaking, this is of little concern so long as the requested recipient is a qualified 501(c)(3) charity.

Private Foundations
Private foundations can serve as an effective giving vehicle, particularly for individuals with a larger pool of charitable assets. There is no minimum per se to establish a private foundation, though many tax and legal experts recommend a minimum of $2,000,000 to $3,000,000. This higher recommended amount is attributable to several key factors – various start-up expenses, annual IRS reporting requirements, excise taxes (1-2% of annual net investment income) and an annual 5% distribution requirement.

The Basics
• The donor engages various tax and legal professionals to create the private foundation.
• The donor makes an irrevocable gift to the foundation and receives an immediate charitable tax deduction.
• The donor chooses to invest the foundation’s assets as desired.
• The donor makes annual gifts to various recipients, keeping in mind the 5% annual distribution requirement.

Advantages
• The donor (or board, if applicable) retains total control.
• The donor can set up the foundation to run in perpetuity by naming successors or a board.
• The donor can engage family members to be part of the philanthropic process and, in doing so, can emphasize core family values.
• The donor can pay reasonable compensation to board members/staff for their services for the foundation.
• The donor/foundation can give to certain foreign non-profit organizations, so long as certain IRS guidelines are followed.
• The donor/foundation may establish a scholarship program, so long as certain IRS guidelines are followed (“self-dealing” is strictly prohibited).

Disadvantages
• Due to various ongoing administrative expenses and annual payout requirements, a high initial funding amount is recommended ($2MM-$3MM+). 
• Initial start-up expenses to create the foundation could be as much as $10,000.
• Annual IRS reporting requirements
• Annual 5% distribution requirement
• Excise tax of 1-2% on the foundation’s annual net investment income
• Recordkeeping requirements – the foundation should document grants and keep meeting minutes
• Lower AGI deductibility limits for charitable contributions (relative to a donor-advised fund)
Hybrid Strategy (Donor-Advised Fund + Private Foundation)
Because both donor-advised funds and private foundations have certain unique advantages, some donors may benefit from a hybrid approach that utilizes both.  

Given the 5% annual distribution requirement for private foundations, the donor may be reluctant to make the 5% annual distribution in years with poor investment returns; in this case, the donor might choose to meet the annual distribution requirement by gifting a portion to various recipients with the remainder donated to a “sister” donor-advised fund. In doing so, the donor meets the foundation’s 5% distribution requirement while effectively distributing less than 5% by retaining assets in the “sister” donor-advised fund for future giving (the donor-advised fund does not have an annual distribution requirement).

For example, a private family foundation of $5 million faces a minimum required distribution of $250,000 for the year. In a particular year, the foundation portfolio declines -10% and therefore, the donor prefers to avoid the required $250,000 distribution. The donor elects to gift $100,000 from the foundation to various charities and $150,000 to the “sister” donor-advised fund. The donation to the donor-advised fund ($150,000) is retained for future charitable giving. Special Note: a private foundation is allowed to make gifts to a donor-advised fund, but a donor-advised fund cannot make gifts to a private foundation; such transfers are a “one-way street.”

The hybrid approach may also be effective if the AGI limits for charitable deductions would make a difference in a given tax year for charitable contributions to the private foundation versus the donor-advised fund. Additionally, if the donor wanted to make grants anonymously, the foundation could make a grant to the donor-advised fund, and the donor-advised fund could then make the grant anonymously.

Benefits of the Hybrid Approach
• Greater flexibility in meeting the private foundation’s annual distribution requirements 
• Greater flexibility in tax planning (charitable deductibility)
• Greater flexibility in making grants anonymously
The table below briefly summarizes key features of donor-advised funds and private foundations.
Please contact any of the professionals in The Wealth Office™ for more information or to discuss the consulting services provided by DiMeo Schneider & Associates, L.L.C.
This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. Content is privileged and confidential. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent median expectations and actual returns, volatilities and correlations will differ from forecasts. Past performance does not indicate future performance. This paper does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice."  
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