Private Foundations vs. Donor-Advised Funds

For very high net worth people looking to maximize the impact of their charitable giving, a private foundation comes to mind. Its primary advantage is the flexibility to give directly to recipients in need. However, there are some distinct disadvantages that should motivate sponsors to consider the alternative of a donor-advised fund (DAF), which is an account established at a public charity that allows donors to make a charitable contribution for an immediate tax deduction. Subsequently, donors recommend grants from the fund to charitable organizations whenever they choose. As with a Roth IRA, Health Savings Account, or a 529 plan, the growth in the assets is tax-free.

With the required specialized state and federal filings, establishing a private foundation can be costly. The sponsor should expect to spend anywhere from $4,500 to $25,000 in legal fees, according to the American Endowment Foundation. A DAF, on the other hand, has no initial setup costs. Additionally, private foundations incur ongoing expenses for taxes (1-2% of income and realized gains), staffing, rent, travel, accounting, annual filing costs, and other operational expenses. Aside from potential investment advisory fees, a DAF will incur an annual administrative fee, usually under 1% of assets.

Donations to private foundations receive less favorable tax treatment than donations to DAFs. While cash donations to a foundation are deductible up to 30% of adjusted gross income (AGI), they are deductible up to 60% of AGI for a DAF. Both allow a 5-year carryover. For appreciated assets, the allowable foundation deduction is 20% of AGI compared to 30% for a DAF.

Private foundations are legally required to disburse a minimum of 5% of their holdings annually, regardless of market conditions. Furthermore, donations and investments made by the foundation are a matter of public record. One possible workaround is to create a complementary DAF to the foundation. In our opinion, a private foundation only begins to make sense at an initial amount of $5 million or higher. In some cases, it may be desirable to collapse a foundation into a DAF. Of course, this should only be done with the assistance of a competent attorney.

Regardless of which type of charitable giving vehicle you are utilizing, you may benefit from working with a low-cost yet highly-credentialed investment fiduciary. If you would like more information on establishing a DAF, please call us at 800-345-4635 or email us at info@clarityca.com.