If leaving a charitable legacy is important to you, you may be thinking about establishing a private foundation or other vehicle for managing your philanthropic activities. Private foundations can be highly effective, but they’re expensive to set up and operate. Donor-advised funds (DAF) are a popular alternative, but also have potential drawbacks.
Immediate Deductions are Possible
Why use a foundation or donor-advised fund? Can’t you just write checks to your charities of choice? Of course, but contributing funds to a private foundation or donor-advised fund allows you to enjoy immediate charitable tax deductions without needing to identify specific beneficiaries or make contributions right away. It gives you more time to research potential recipients or change the organizations you support from year to year.
These vehicles also allow you to involve your family in your charitable endeavors. You can name family members to the board of a private foundation or even hire loved ones to manage it. Many DAFs allow you to designate a successor advisor.
How They’re Structured
A private foundation is a charitable organization, typically structured as a trust or corporation, and designed to accept donations from a small group of people, such as you and your family. Private foundations usually make grants to other charitable organizations rather than provide charitable services themselves.
A donor-advised fund is an investment account, controlled by a sponsoring organization — usually, a public charity or community foundation — and often managed by an investment firm. The fund accepts tax-deductible contributions from investors, who advise the fund on how their charitable dollars should be spent.
Pros and Cons of Foundations and Donor-Advised Funds
Donor-advised funds generally can be set up in a matter of days — or even hours. Setting up a private foundation, however, takes time, since it involves establishing a legal entity. Another advantage of donor-advised funds is that they’re inexpensive (or free) to create, and minimum initial contributions can be as low as $5,000. In contrast, starting a private foundation involves significant legal and accounting fees. Foundations also require much larger initial contributions — typically hundreds of thousands or even millions of dollars — to justify their start-up and ongoing administrative expenses.
Comparisons to Consider
Operating Expenses–Donor-advised funds typically charge management and investment fees of around 1% to 2% of your account balance. Managing a private foundation is much more expensive since you’ll need to appoint a board, hold periodic meetings, keep minutes, file separate tax returns, and incur ongoing legal and accounting costs, in addition to paying investment fees. You’ll also need to hire a staff or engage a third-party administrator, and pay an excise tax on net investment income (currently 1.39%).
Distribution Requirements–Donor-advised funds aren’t subject to required minimum distributions, so investments can grow tax-free indefinitely (subject to any rules of the sponsoring organization). But private foundations must distribute at least 5% of their net market value each year.
Charitable Recipients–Distributions from donor-advised funds must be made to public charities. Private foundations can make grants to a wider range of charitable recipients, including individuals (subject to certain restrictions).
Tax Deductibility–Cash contributions to donor-advised funds are tax deductible up to 50% of the donor’s adjusted gross income (AGI), while noncash contributions are generally deductible up to 30% of AGI. For private foundations, the deduction limits are 30% and 20%, respectively. Typically, you can deduct the market value of appreciated assets donated to a donor-advised fund. Deductions for donations to foundations are limited to your cost basis (except for publicly traded stock).
Privacy–Donor-advised funds are permitted to accept donations privately, so it’s possible for contributors to remain anonymous. Private foundations must publicly disclose the names of donors who give more than $5,000.
Control–This is an area where private foundations have a clear advantage. You and other board members retain full control over the foundation’s investments and distributions. Donor-advised fund contributions become the sponsor’s property and your role in managing investments and distributions is strictly advisory. Practically speaking, however, sponsors almost always follow contributors’ advice.
Your Philanthropic Strategy
The right charitable giving vehicle for you depends on many factors, including your financial resources, the charities you wish to support and the level of control you desire. Talk to your advisors about designing a philanthropic strategy that meets your needs. Our estate, trust and gifting specialists can answer your questions about which charitable giving method is best for your situation. Contact us for more information.