DAF or Private Foundation: Which is Right for You?

Sharing wealth and establishing a family culture of philanthropy are important values for many wealthy individuals and successful business owners. According to Wealth-X, ultra-high-net-worth individuals accounted for 36% of all individual giving in 2019.

Whether you're devoted to improving health outcomes for impoverished families or you're focused on education, social justice, hunger or the environment, there are a variety of ways to maximize the impact of your financial donations while mitigating tax liability.

Two of the most common options used by wealthy families to manage their philanthropic activities are Donor Advised Funds (DAF) and private foundations. A DAF is an account that allows someone to make a donation, get an immediate tax benefit, and choose the organization that money goes to at a later date. It also allows a person to continue their giving as the DAF grows.

“DAFs have increased in popularity over the past decade, primarily because they are simple to establish," said Chris Van Atta, national client development manager for RBC and City National Bank. “A private foundation can be more complex and expensive to set up."

In 2019, there were approximately 873,228 DAFs in the U.S. with nearly $142 billion in assets, according to the 2020 DAF Report from the National Philanthropic Trust, and about 90,000 private foundations.

Approximately $28 billion in charitable donations in 2019 came from DAFs and approximately $54 billion came from private foundations. Charitable donations from DAFs increased 93% between 2015 and 2019 and contributions to DAFs increased 80% during that same timeframe, according to the National Philanthropic Trust.

 

Differences Between Donating to a DAF and a Private Foundation

Choosing the right vehicle for your charitable donations can be almost as important as determining which cause matters most to you and your family.

“When you donate to a DAF, you're giving to a fund that manages your money and then makes donations to 501(c)(3) charities per your request," said Van Atta. “When you establish a private foundation, you create a 501(c)(3) charity that provides grants to various organizations and causes."

The money you contribute to both vehicles is invested and grows tax-free.

“One disadvantage of a DAF is that you have less flexibility with your investments, but sometimes you can use your existing financial advisor to manage your assets," said Van Atta. “Private foundations manage their own funds and typically work with an investment advisor."

When you're ready to donate to a charity, you request the donation to be made by the DAF. The DAF's board approves or disapproves the donation.

“Technically, you don't have control over your donations because you're making a suggestion rather than a direct donation," said Van Atta. “But 99% of the time DAF donations are approved and the DAF writes the grant."

Private foundations have complete control over their donations. While a private foundation can donate to an individual facing hardship as long as the situation meets IRS restrictions, DAF donations must be made to a public or private charity.

“You also have privacy if you want it with a DAF, since a DAF donation can be made anonymously," said Van Atta. “Donations made by private foundations must be reported and made publicly available in the foundation's annual report."

If your donation will be in cash, either charitable vehicle works, but if you have other assets to donate that could tip the scales to a foundation.

“If you have an art collection or antique car collection worth $10 million, you may want to consider a private foundation that can handle those assets," said Van Atta. “A foundation might be able to loan or rent those assets for income."

Typically, DAFs are funded with cash or highly appreciated stocks.

“Technically, you can also donate real estate to a DAF, but that can create a unique set of circumstances that should be worked through with a financial advisor," said Van Atta.

 

Advantages of a DAF

The prime advantage of a DAF is that it has few barriers to entry, said Van Atta.

“You can set up a DAF in a day or less and there's no fee to open one," he said. “While DAF requirements vary from one organization to another, at City National Bank the minimum donation is $25,000."

Contributing to a DAF is as simple as donating to a traditional charity because all the administrative details are handled by the DAF, said Van Atta.

While private foundations must donate 5% of their assets annually, you're not obligated to charitable giving every year with a DAF. With that option, your assets can grow tax-free for years before you choose to donate them or pass them onto your heirs, said Van Atta.

Benefits of Donor-Advised Funds: Flexibility

Donor-Advised Funds have grown in popularity in recent years as a charitable giving tool mainly because of their flexibility.

“You can contribute to the DAF as frequently as you would like to and then recommend grants to charities whenever you feel it is worthwhile, as it is today during the pandemic," said Alma Banuelos, head of Trust and Estate Services for City National Bank. “The grants can be made as frequently or infrequently as you want."

This type of flexibility for contributions can be helpful in national and international times of crisis, when you want to support a nonprofit but may not have the ability to donate as you normally would.

If you're interested in donating to nonprofits serving those impacted by COVID-19, for example, you can recommend donations of some of the funds that may have accumulated in your DAF over the years.

Furthermore, you're afforded privacy. Donations made through a DAF can be given anonymously from the DAF to the charity, said Banuelos.

“The DAF manager fully vets all nominated charities for you. This ensures they are legitimate and properly using the funds as you intended," she said.

Benefits of Donor-Advised Funds: Taxes

In addition to this flexibility, DAFs offer numerous tax benefits to the donor, such as:

• Income tax. Contributions to a DAF qualify for an income tax charitable deduction for the year in which you contribute to the DAF. Concerned about your unused deductions? There is a five-year carry-forward period for those.
• Alternative Minimum Tax (AMT). Your contribution to a DAF may lessen the impact of AMT.
• Estate tax. Balances in the DAF are not included in your estate for estate tax purposes.
• Tax-Free Growth. The DAF investments can appreciate tax-free.
• Capital Gains Tax. Gift of appreciated or illiquid assets, including real estate, to a DAF do not incur capital gains tax.

In 2018, U.S. charitable giving of all types amounted to nearly $428 billion nationally, 68% of which was given by individuals, according to the 2019 DAF Report by the National Philanthropic Trust, a public charity that sponsors a DAF.

Charitable donations from DAFs in 2018 alone totaled over $23 billion.

 

When to Consider a Private Foundation

If you have a larger sum to invest, such as at least $2 million, you may want to evaluate the benefits of a private foundation. Private foundations are more commonly established with an investment of $10 to $50 million, said Van Atta, and can be used to establish scholarships or help individuals as well as other charities.

“The main benefit of setting up a foundation is that you have complete control over your money," said Van Atta. “It takes time and money to file the paperwork to establish a 501(c)(3) and you need to employ an attorney, find board members, hold annual meetings and provide minutes of those meetings. But you get to control your investments, choose your board members and choose your charities."

Foundation operators can hire family members to run their organizations.

“Some families like having a private foundation because they require an annual meeting," said Van Atta. “This means everyone involved is more hands-on. It's a way to create a pattern of intergenerational giving."

 

Tax Implications of a DAF vs a Foundation

While many philanthropists are primarily concerned about the efficacy of their donations and become deeply involved in charitable organizations and causes, contributions also offer a tax benefit.

“When you use a DAF as your charitable vehicle, you can deduct your cash donations up to 60% of your adjusted gross income," said Van Atta. “If you gift illiquid assets such as real estate, you can deduct the full market value up to 30% of your adjusted gross income in a DAF."

Tax deductions are more limited in a private foundation and are capped at 30% of your adjusted gross income for cash contributions and 20% of your adjusted gross income for other contributed assets.

 

Why You May Want Both a DAF and a Private Foundation

While Van Atta said that DAFs tend to be more popular with donors because of their simplicity and high level of deductibility, some private foundations use a DAF for their donation requirements.

“If a foundation doesn't have a specific charitable donation they want to make in a given year, they can take 5% of their assets and donate them to a DAF," said Van Atta. “They can then make a donation from the DAF in the future or let the money grow for years in the DAF."

As with any major financial decision, it's smart to consult a wealth advisor and estate planner to analyze your unique goals for your family and your philanthropy before deciding whether a DAF, a foundation or a simple charitable donation makes sense for you.