When philanthropic individuals and families think about their larger giving strategy, they tend to first focus on the “who” and the “how much.” Everyone has different priorities and motivations around which charities and causes to support and what amount they can and should give. But the reality is, how charitable dollars are managed and allocated also plays a significant role in advancing a sound philanthropic strategy and ensuring you maximize sustained giving.
Today’s donors have several grantmaking pathways to consider, whether that’s giving directly in the moment or giving with longer-term, strategic giving vehicles. When it’s the latter, often the choice comes down to a donor-advised fund (DAF) or a private foundation. Both offer unique benefits depending on specific philanthropic priorities. Making the right choice starts with understanding more about each of these giving vehicles to see which best aligns with your larger philanthropic strategy. Here’s a high-level definition of each:
- Donor-advised fund: An account that is owned and operated by a public charity (known as a sponsoring organization, such as Vanguard Charitable) that is dedicated to supporting charitable purposes and designed exclusively to invest, grow and contribute assets to other charities for meaningful and lasting impact. It is a low-cost, convenient and tax-efficient charitable giving tool.
- Private foundation: An independent charitable organization with governing legal documents and a governing body with complete control over investment and grantmaking decisions. It is a customizable and high-touch charitable giving tool.
As the definitions show, there can be an overlap between these two giving vehicles. Often, decisions around which vehicle to utilize have less to do with what is technically possible and more to do with which one will allow donors to maximize their charitable giving in a tax-smart manner and expand their impact. With that framework established, here’s a closer look at how donor-advised funds and private foundations compare across a few key donor priorities.
Supporting targeted causes and charities
Both donor-advised funds and private foundations can be used to make grants to public charities across a wide range of causes and focus areas. Private foundations are typically better suited for giving to 501(c)(4) organizations (or other non-public charities) or specific individuals, provided the grants are used for charitable purposes and certain procedures are followed. (Allowable grants to specific individuals can include scholarships for study or travel, as well as emergency assistance following a disaster or personal hardship.)
Both private foundations and DAFs can be useful vehicles for donors who have dedicated focus areas as part of their philanthropic strategy — such as funding public charities addressing education inequality in an innovative way.
While both private foundations and DAFs can be used to grant to public charities, a DAF offers grantmaking capabilities with added flexibility and scale, because the sponsoring organization conducts due diligence and handles the administrative side of grantmaking. Sponsoring organizations also often provide philanthropic advice and grantmaking resources to help fundholders develop and implement year-round giving strategies that accommodate ongoing, urgent and emerging needs.
Engaging in collective giving
A private foundation can create a shared set of rules and values for philanthropic efforts for a family unit or other group to streamline decision-making and limit conflict. The board of a private foundation can help build out a consistent framework to drive those efficiencies.
Similar to a private foundation, DAFs are a good tool for families looking to establish philanthropic values and involve their family members in strategic charitable giving. Numerous family members can be appointed as advisers to a single DAF, providing the next generation with an opportunity to be involved in setting and implementing a family’s philanthropic vision over time.
Balancing capabilities and administrative costs
Because private foundations are often designed to meet the needs of founding donors, there are specific solutions and services that can be incorporated into their structure. However, these elements come at a cost. For example, there are additional financial considerations and legal expenses to consider when establishing and maintaining a private foundation, including accounting expenses, compliance regulations, required minimum distributions (RMDs) each year and the need to build out a board.
At a private foundation where a family or business is involved in the giving and the administration, there’s greater capacity for overlap between the governing body and the donors.
In comparison to private foundations, DAFs have fewer associated costs. For sponsoring organizations with national reach, annual administrative fees are typically around 0.6%, and investment fees range from 0.015% to 0.99%, depending on the sponsor.
In terms of grantmaking governance, with a private foundation, the board of the foundation must approve grants. With a DAF, the moment assets are put into a fund, the donor technically cedes ownership and control over the funds to the sponsoring organization. When a donor is ready to make a grant, the donor or a donor-appointed adviser recommends a grant, which the sponsoring organization must approve before distribution.
In return for ceding ownership and control, DAF holders benefit from economies of scale, including lower overhead costs and a governing body that manages all grantmaking, investment and administrative matters.
Privacy is another consideration for some donors who may want to avoid the spotlight or ensure all positive attention remains on the charity they choose to support. If desired, grants can be made anonymously with DAFs, whereas private foundations must identify all grantees when they file their IRS Form 990-PF, which is publicly available.
Realizing tax benefits
By using a private foundation or DAF, donors are making a charitable commitment to support nonprofits. With both giving vehicles, funds are donated to a charitable organization, enabling donors to receive an immediate tax deduction. While the funds in either vehicle can generally be invested and grown until the donor is ready to recommend grants to eligible nonprofits, private foundations are nevertheless required to distribute approximately 5% of their assets each year for charitable purposes.
Both options offer tax advantages, including tax-deductible contributions, but, overall, DAFs tend to be more tax advantageous. DAFs have higher limits for charitable deductions than private foundations, and while private foundations are exempt from federal income tax, they must pay a 1.39% excise tax on net investment income and realized capital gains.
At tax time, sponsoring organizations provide DAF account holders with a single itemized list of contributions and grants, simplifying tax-reporting needs. All DAFs, whether operated by a community foundation or a different type of sponsoring organization, provide increased tax advantages, meaning a greater portion of giving can go to charity.
With a DAF specifically, the sponsoring organization will generally follow donors’ or their advisers’ grantmaking recommendations, provided they align with the sponsoring organization’s policies and satisfy legal requirements — such as the charity being an IRS-approved 501(c)(3).
Donating complex assets and leveraging investment options
When it comes to donating appreciated securities or complex assets, DAFs are typically the more cost-effective and capable option for converting those assets into liquid assets. Sponsoring organizations have built an infrastructure and streamlined approach to process complex assets and convert them into dollars for charity. In contrast, many private foundations are ill-equipped or unable to handle the donation of certain complex assets, and those that do accept tend to come with a less favorable tax treatment for donors.
After liquid assets are contributed to a fund, different vehicles will have different considerations for how those assets are invested. A private foundation may, within certain parameters, allow for investments in funds that are higher risk and possibly high yield, whereas a DAF will typically use marketable securities such as mutual funds or ETFs to achieve steady, sustainable growth. Here again, private foundations may offer more flexibility and control but at an additional cost.
The right vehicle is the one that aligns with your goals
For some individuals, combining the two vehicles will be the best way to accomplish their specific philanthropic goals. A private foundation may use a DAF for a number of reasons, including to instill charitable values in younger generations; to give younger generations greater autonomy; to access lower fees, less overhead and fewer administrative burdens; and to tap into industry or local expertise.
It’s also worth noting that private foundations and DAFs are not the only giving vehicles that philanthropically minded individuals and families may wish to consider. Additional examples, to name a couple, include designated funds, which maximize giving to the same organization on a recurring basis, or field-of-interest funds, which are uniquely positioned for giving focused on a specific cause.
Ultimately, the vehicle you select is about ensuring as much of your contribution as possible goes to making a positive impact on the nonprofits you choose to support now and into the future.
