Ethics Review: Donor Advised Funds

By John Gravley

Literature and religious writings are filled with attempts to understand how and why “good” people, intentions, or ideas can bring about “bad” actions, outcomes, or results.  In Greek Tragedy, Aristotle developed the term, hamartia, to describe the tragic hero’s one fatal flaw that sets some larger tragedy in motion.[1]  Early Christian writers modified the term to describe any well intentioned act that misses the intent and leads to some less than good consequence.   Any well-intentioned action or idea that ends up becoming something other than what was intended is described as a failure. In the charitable giving world today, Donor Advised Funds (DAFs) are the well-intentioned vehicle that has caused an ever-increasing amount of charitable gifts to miss the mark of supporting charitable causes.  Originally created to provide individuals more control over their yearly (tax break encouraged) charitable gifts, DAFs remove the time urgency to actually give charitable dollars to charities and have been hijacked by large financial institutions who hold the funds in limbo.  DAFs have failed their intended goal of providing greater charitable support.

Donor Advised Fund (DAF)

A philanthropic giving vehicle administered by a charitable sponsor. A donor-advised fund allows donors to establish and fund the DAF account by making irrevocable, tax-deductible contributions to the charitable sponsor. Donors then recommend grants from those funds to other charitable organizations. The charitable sponsor retains legal control over all assets in the DAF and the donor retains advisory privileges to make non-binding recommendations regarding grants and investments. (from National Philanthropic Trust)

Background: Encouraging Individuals to Support Charities

1917 – US Revenue Act introduces the individual income tax deduction for charitable donations.[2]

1931 – First DAF introduced by the New York Community Trust and supported and sustained by John D. Rockefeller Jr.

• The goal was to give an individual donor control over where her charitable dollars go.  Until the DAF, the board of a charitable trust made the decisions for all donors who had given to the trust.  Individuals with large charitable gift potential wanted a way to be able to directly guide their charitable dollars.

1991 – Fidelity Investments became a DAF sponsor, becoming the first commercial DAF, which accelerated the growth of the charitable vehicle.[3]

2012 and 2017 – Two of the largest jumps in giving to DAFs in the last decade happened when tax policy discussions threatened the value of the charitable deduction. The first was in late 2012, when scheduled tax cuts and federal budget disputes occurred at the same time, creating the “fiscal cliff.” That year-end event threatened the existence of the charitable tax deduction, which, thankfully, was preserved. The second was at the end of 2017, when Congress debated and ultimately passed the Tax Cuts and Jobs Act. Tax policy clearly affected giving behavior.[4]

2010 to 2018 – the number of DAFs increased 300%.[5]

Today: What The Numbers Tell Us

In 2019 according to the 2020 DAF Report by the National Philanthropic Trust[6], gifts to charities from DAFs totaled more than $25 billion dollars and contributions to individual DAFs totaled more than almost $39 billion (That $39 billion is almost 13% of all individual charitable giving in 2019 going to a DAF instead of a charity).  The quick math on these numbers shows that in 2019, the amount of charitable dollars that did NOT go directly to charitable activities (contributions to DAFs minus gifts from DAFs to charities) was almost $14 billion.  That amount was parked in a “charitable” instrument that does nothing except draw interest and provide an ever-growing balance sheet for whatever foundation or financial institution holds the DAF.

Unintended Consequence #1 – More and more charitable dollars are being held in limbo and are not going to actual charities.  The urgency to give has been removed.

The intention of donor advised funds is to provide a way to take a charitable tax credit immediately on the money used to set up the DAF and allow more “freedom” or “flexibility” on when to give the actual charitable dollars to a charity.  A person can then take more time to consider how to use the charitable dollars.  There is no longer any incentive to give the funds in any particular timeframe.  The personal financial benefit has been realized. 

These funds are sold as a “helpful” tool for a person to be more thoughtful or intentional in their philanthropy.  There is the added opportunity for the person to pass the DAF down to children, so the children can learn about philanthropy.  There is even an appeal that the DAF can “grow” in value as the DAF funds are invested.

However, the individual charitable deduction that was created in 1917 was created to encourage individuals to give to charitable causes in the tax year.  It encouraged and rewarded individual gifts to charitable causes in a specific timeframe.  The charitable gifts were to support charities, not go into charity purgatory.

Unintended Consequence #2 – Large Financial Institutions Hijack Charitable Funds to Boost Profits

A financial institution is more than willing to hold these DAFs and “grow” these funds for a small fee.  If a financial institution does not offer DAFs, a charitable gift will “leave” the financial institution in the form of a gift.  However, with DAFs, the client’s charitable gift now does not have to “leave” the financial institution.  It just has to be transferred from the client’s account to the client’s DAF account.  The client can only use the funds to make “recommendations on” payments to a charity but the financial institution continues to hold any funds until an actual transfer is made.  Fees for the management of DAFs are varied.  Some charitable foundations have a flat fee as low as $500 per year.  Schwab and Fidelity have variable fees based on the amount in the fund.  The fees start at 0.60% or $100 on the first $500,000 and are as smaller percentage as more money accumulates in the DAF.[7]

Top 10 Donor Advised Funds – 2018

The list of DAF holders shows the value these funds can create for a financial institution.  In 2018 three of the top four holders of DAFs were large financial institutions holding almost US$14 billion in DAFs or almost double the combined holdings of the other six of the top ten.  Financial institutions benefit from having more funds in their portfolios.  Unfortunately, there are no incentives for individuals who own DAFs or institutions that hold DAFs to actually give any portion of the “charitable” dollars held in those accounts.

“All funds in DAFs managed by financial institutions get invested in that institution’s mutual funds, wherein the institution takes a cut. The more assets the financial institution manages, the more they can charge in annual fees.”[8]

The Failure

This DAF ecosystem leads to the ethically questionable unintended consequences.  Money that previously would have gone directly to charitable activities is now held in limbo for an indefinite period.  The National Philanthropic Trust celebrates the growing amount of funds held in DAF’s saying, “The rapidly increasing number of individual DAF accounts make them the fastest-growing vehicle in philanthropy, and the rising value of charitable dollars granted from DAFs also makes them the most active philanthropic vehicle.”[9]  It even celebrates the percentage (20%) of those funds that is then actually passed on to charities.  So almost 80% of charitable dollars languish in DAFs.

The unintended consequences of DAFs:

• Charitable dollars that would have been given directly to a charity can now be parked in a holding fund indefinitely.
  • Individuals are relieved of the “tax” incentive to actually search for charities to support.

• Financial institutions who offer DAFs now compete with actual charities for these charitable dollars.
  • There is a hidden incentive for DAFs to hold funds and grow.  If a financial institution can “help” a client invoke the charitable deduction tax benefit and the institution can retain the funds to be managed, the financial institution wins.  No funds are transferred out of the institution and the institution can charge a new set of fees on the funds being held.

So, the idea behind DAFs is well intentioned, but the reality is they often miss the mark of the intent.  They remove significant charitable funds from being able to actually help real people in need.

Policy Recommendations

1. DAFs should be required to make a minimum distribution each year.  This was the intent of the charitable deduction on taxes. At least 50% of the value should be required to be given each year.
2. The incentive for large financial institutions to hijack these funds and keep them on their books should be limited or removed.  For-profit institutions should not be able to charge any fees on DAFs. 

Dr. John Gravley is Chief Advancement and Business Development Officer at Child Aid, a literacy training NGO working in rural Guatemala.

[1] https://literarydevices.com/hamartia/

[2] https://www.irs.gov/pub/irs-soi/tehistory.pdf

[3] https://thesignatry.com/daf-history/

[4] https://news.bloombergtax.com/daily-tax-report/insight-donor-advised-funds-in-the-%20new-decade

[5] https://news.bloombergtax.com/daily-tax-report/insight-donor-advised-funds-in-the-%20new-decade

[6] https://www.nptrust.org/reports/daf-report/

[7] https://www.philanthropy.com/article/administrative-fees-for-donor-advised-funds/

[8] https://www.classy.org/blog/dafs-pose-problems-nonprofits-social-progress/

[9] https://www.nptrust.org/reports/daf-report/