Donor-advised funds, the fastest-growing method for charitable giving among Americans, have attracted criticism, including the allegations that these vehicles are used to avoid taxes, that financial services firms impose excessive management fees and that DAFs undermine American philanthropy by not distributing their assets for years, in some cases.

A report released this week by the Manhattan Institute’s Howard Husock finds that most complaints about DAFs are misplaced, and that on balance, they are a boon to the charitable world, although there is room for improvement with regard to how DAFs handle assets undisbursed at the time of a donor’s death.

DAFs and Taxes

According to the report, donors can realize charitable tax deductions relatively easily, especially with vehicles managed by the likes of Vanguard Charitable and Fidelity Charitable, which are tax exempt. Donors can seamlessly transfer assets from their personal accounts into their DAF accounts.

The report says some critics consider this “an enhanced tax deduction,” alarmed that donors can realize a tax deduction with such a transfer rather than contributing funds to an operating charity.

The Manhattan Institute paper counters that DAFs encourage more giving by reducing donors’ tax burden.

It points to a National Philanthropic Trust report that DAF assets grew from $57 billion to $71 billion during 2013–14 and grants held steady at 22% of assets. During the same period, private foundation grants totaled 5.8% of assets.

Management Fees

Schwab Charitable, Vanguard Charitable and Fidelity Charitable house the fastest-growing crop of DAFs, and all charge management fees, according to the report.

A major criticism holds that these sponsors’ business model is to earn a profit from the fees they secure.

The report says this criticism omits the fact that “any charitable donation” will be directed to an investment account — a bank account, a reserve fund or an endowment — that will incur a management fee. The possible exception is a direct donation to an operating charity to pay for current expenses.

“The management fees charged by such firms are comparable with those charged by local community foundations, the other major ‘sponsor’ (i.e., manager) of DAFs.”

DAFs and ‘Orphan Assets’

The report says that both national financial services firms and community foundations ask donors where undisbursed assets should go at the time of their death. They are not required to say, but typically they either:

  • Designate an individual successor, perhaps a family member
  • Designate a specific charity to receive all remaining assets, in which case the DAF would be closed
  • Direct all remaining assets to a so-called endowed giving program, where grants go to designated nonprofits over time, after which the DAF would close down

At local community foundations, the report says, donors can feel assured their charitable goals will be pursued even if they have not chosen one of these options. Such foundations, whose broad goals the donor knew before opening an account, disburse “orphan assets” at their discretion.

This is not the case of national financial services firms, according to the report, as they do not have “cause-related” missions; they exist only to facilitate DAFs.

These firms transfer undisbursed assets to general charitable funds managed by boards of directors and staff who decide where to direct assets—sometimes to causes never chosen by their original donors. Disbursement to bona fide charities is required by these firms’ policies.

The report notes, however, “the lack of any donor mandate or direction is troubling and will become more so as total DAF assets at such firms — and thus, orphan assets — rise in future years.”

To ensure that these funds stay true to their name, Husock recommends that major DAF sponsors implement policies that would require funds to be distributed in line with donors’ previous giving patterns.

— Check out U.S. Philanthropy Becoming Increasingly ‘Top-Heavy’: Report on ThinkAdvisor.