There are many reasons to launch a charitable vehicle, such as tax benefits, not to mention the satisfaction of supporting causes you believe in and allowing nonprofits to further their missions. Most people give to charity through cash, but it is not always the most efficient option, especially from a tax perspective. If you decide to launch a charitable vehicle, you may end up choosing between two different popular options: a private foundation or a donor-advised fund. While you should ideally discuss these options with experts in tax and finance, you should also have a basic understanding of the options and their pros and cons when you enter the conversation.
A Look at Private Foundations
At the most basic level, a private foundation is a nonprofit organization that involves a primary donation from an individual or a business. Foundations have trustees or directors that help manage the funds and programs. With a private foundation, donors have a lot of control over operations and how funding occurs. For example, private foundations can hire staff members that are paid by the organization itself. Often, owners of private foundations hire their family members to help guide donations and research potential recipients. The organization’s board maintains full control over grantmaking as well. Some larger foundations become the recipients of donations themselves. This money can then be distributed through the foundation as it makes various grants.
If you want to maintain complete control over how the money is distributed, consider a private foundation. For example, your private foundation could make grants to other nonprofits or even to individuals who may be facing personal hardship or who have recently experienced some sort of emergency. Donor-advised funds are stricter about the types of grants that can be made with the money in the account, so people who want absolute freedom in terms of giving tend to stick with private foundations.
An Introduction to Donor-Advised Funds
Donor-advised funds, or DAFs, are essentially accounts that contain money earmarked for charitable giving. You can put cash and appreciated assets and securities into the account. Then, the fund makes gifts to the charitable organizations you designate over a long period. The major benefit of donating to a DAF is that you get a deduction for the current tax year but do not necessarily need to make an immediate decision about where the money will go. The DAF holds assets until you are ready to distribute them.
Most of the organizations that sponsor DAFs impose time limits on how long you can go without making a charitable donation, so you may feel pressured to give before you are ready if you go with this option. Furthermore, disbursements must be made to 401(c)(3) public charities, so you can be limited in the types of organizations that you can support. Before you decide on a DAF, it is important to understand the specific rules imposed by the sponsoring organization. Also, proposed legislation could change how DAFs work in the future, so it is important to think about that, especially since these accounts have come under pressure for not making enough donations.
Comparing the Two Major Philanthropic Options
As you choose between a private foundation and a DAF, there are various points you should consider. Two of the key points to look at are setup costs and management fees. A DAF costs nothing to set up, and the management fees can be $5000 or more. On the other hand, a private foundation requires legal and accounting fees to start, and management fees can be in the hundreds of thousands depending on the extent of the operation.
At the same time, you have more control with a private foundation, including operating expenses, than you do with a DAF, which has fees primarily imposed by the sponsoring organization. The other point to consider is that foundations typically, although not necessarily, hold a lot more money than DAFs.
DAFs provide for anonymity and have no minimum distributions at the individual account level. However, succession rules can vary quite a bit. With a private foundation, anonymity is much more difficult, and they are required to meet a 5 percent annual minimum distribution. At the same time, there are clear pathways for succession. Furthermore, foundations face an excise tax whereas DAFs do not.
In terms of tax deduction as a percent of adjusted gross income, for DAFs it is 60 percent for cash and 30 percent for appreciated assets. For foundations, it is 30 percent for cash and 20 percent for appreciated assets. Thus, DAFs offer a superior tax advantage but have more restrictions.
DAFs are also restrictive in terms of investment options. Some allow you to choose between mutual funds and individual securities, but this is organization-dependent. With private foundations, the organization itself has control over investments, so you are not really limited at all.