Donor Advised Funds: Meaning, How They Work, and Could They Help You?
A major crisis or widespread emergency can happen at any time, and that’s often when nonprofits do their most valuable work. Funding is a major concern when disaster strikes, and donor-advised giving provides a way for donors to invest and grow funds to make them available at dire, unexpected times of need.
Donors and nonprofits alike get a lot of value from donor-advised funds. We’ll explain what donor-advised funds are, how they work, and describe the potential they have for your nonprofit.
What Are Donor-Advised Funds?
To give you some perspective, let’s take a brief look at the history of donor-advised funds. The earliest versions of donor-advised funds date back to the early 1930s. By the 1990s, donor-advised funds were steadily growing in popularity. Since then, they’ve become the fastest-growing financial vehicle for philanthropists. In fact, over 3% of all giving in the United States comes from donor-advised funds.
A donor-advised fund account serves as a charitable investment account. The purposed of donor-advised giving is to create an appropriate financial vehicle for philanthropists that gives them the potential to increase the amount of charitable giving.
Donor-advised contributions are irrevocable. Donors can’t withdraw the funds or transfer them to any other individual. The funds must only be used to make grants to charities.
How Do Donor-Advised Funds Work
Sponsoring organizations for donor-advised funds are 501(c)(3) organizations that maintain and operate separate funds or accounts for individual donors. Sponsors can take the form of community foundations, religious organizations, universities, or the charitable divisions of major investment management firms like Fidelity and Charles Schwab.
Donors may contribute funds in the following currencies:
- Cash
- Securities
- Cryptocurrency
- Private company stock
- Publicly traded stock
- Private business interests
- Mutual funds
- Bonds
- Pre-IPO shares
- Life insurance
- Oil and gas royalty interests
- Retirement assets
Donors can make contributions to the fund as often as they choose. The money gets invested, and as it grows, it enables larger giving amounts. Donors get to decide when to donate funds and which charity to award them to. The sponsoring organization generally makes recommendations for making grants, and donors nearly always accept their recommendations.
Donor-advised funds can be given to most tax-exempt public charities that meet the definition of the IRS as a 501(c)(3) organization (and classified as public charities under IRS code 509), including international charities. Certain private operating foundations may also legally receive donor-advised funds. The main benefit of donor-advised funds is the funds grow on a tax-free basis.
Besides the tax advantages, philanthropists can pass their donor-advised funds down to an individual, charity, or both in their wills or estate plans when they pass away.
Donors have the option of making single or recurring grants. They can offer grants to charities under their name or brand, or they can disburse funds with total anonymity. The only stipulation is the funds must be used for charitable purposes.
Benefits of Donor-Advised Funds for Donors and Nonprofits
As with any type of investment vehicle, there are a few donor-advised funds pros and cons for your board to be aware of.
Donors and charities benefit from donor-advised funds. There are relatively few disadvantages of donor-advised funds for donors, and there is no downside for charities at all.
Donors get the benefit of having tax deductions at the state level, federal level, or both. Many donors opt to take the money they save on taxes and invest it in funds. It’s a strategic way to grow funds faster and help charities better.
Charities have a favorable view of donor-advised funds. The investment potential of donor-advised funds typically means they get more money than they could expect with a regular donation. The average payout rate for donor-advised funds averages around a 20% payout rate in comparison with the amount of funds being held. This is significantly greater than the average for private foundations which trends around 7%-8% payout rate.
Beyond their regular donations, charities may be able to count on extra funds during times of crisis, an emergency, or an economic downturn. According to the 2020 DAF Report, the global pandemic, the fight for racial justice, and the tense political climate all contributed to unprecedented DAF activity.
If you’re wondering how much money is in donor-advised funds, philanthropists contributed $38.81 billion in 2019 which is up 80% from the contributions that have been made since 2015. What’s more, donor-advised fund grants totaled $25 billion in 2019 which reflects a 93% increase since 2015. It’s fair to say that philanthropists who leverage donor-advised funding are inherently generous. Currently, there are over 500,000 donor-advised funds within the United States, representing a total of over $100 billion.
Donor-Advised Funds: Disadvantages for Nonprofit Boards to Be Aware Of
A board discussion about donor-advised funds wouldn’t be complete without a review of the disadvantages of this funding source. Fortunately, the disadvantages are few and the benefits of donor-advised funds far outweigh them.
Some sponsoring organizations require a large initial contribution which prevents some donors from taking advantage of them. Also, there’s a small administrative cost to manage donor-advised funds. Costs typically range around 0.6%. While the percentage is small, it adds up, especially in relation to large grants, and it comes directly out of the amount being donated.
On the one hand, the administrative fee makes donor-advised funds less efficient for donors than making direct donations. At the same time, the administrative funds could be offset by the interest the fund gains over time.
Without question, donors have a vast impact on charitable causes. With a BoardEffect board management system, you have unlimited document storage to store an entire library of information about donor-advised funds. The secure online platform makes all the information your board has collected about donor-advised funds accessible to board members and executives any time they need it.
The topic of donor-advised funds makes an excellent topic for board education and board discussion. With BoardEffect’s platform, you can add it to your agenda in an instant and upload it to your online board handbook for easy, online viewing.
