What Is a Donor-Advised Fund, and Is One Right for You?

The GOP's late 2017 tax overhaul has taken the once-popular charitable giving deduction off the table for the vast majority of people who used to claim it. And it may not be a coincidence that since then, donations to charity -- which used to rise at a fairly impressive annual rate -- appear to have gone pretty flat. But there are ways some people can regain a bit of that lost "doing well by doing good" mojo, and in this segment of the Motley Fool Answers podcast, hosts Robert Brokamp and Alison Southwick discuss a couple of them with Phil Buchanan, who heads the Center for Effective Philanthropy.

One is simple -- you can cluster several years' worth of donations into one tax year. The other is a little more complex, but it has been gaining popularity rapidly for a while now: opening your own donor-advised fund, which is essentially a mini-nonprofit that you control. These have obvious benefits for the people doing the donating, but whether their proliferation is good or bad for the charitable world broadly is less clear.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on May 7, 2019.

Robert Brokamp: Obviously there are a lot of good benefits to making donations. I just read an article recently that it actually makes you happier and reduces rates of depression. But some people also like tax benefits.

Phil Buchanan: Correct.

Brokamp: But that's a little dicier, now, because to be able to deduct the contribution you have to itemize, [and] because of the new tax law the standard deduction is so much higher fewer people are itemizing. There is, I think, some concern, that people are going to donate less because of that. Is that true? Do people have that concern? Is there any evidence that that's happening yet?

Buchanan: There is a lot of concern. The data is hard to get your arms around, but in recent years what data is available shows that there's already been a decline in the percentage of households giving. That's due to a decline in sort of everyday givers. That's concerning to begin with.

And then we have the new tax law. Now we don't have the data, yet, on definitive 2018 giving levels, but some early studies suggest that it may have been more like flat -- down in real terms, but flat -- or just a bit up nominally as opposed to pretty healthy growth previously.

Is that because of the change in tax law? It's hard to know for sure. I also think that change will take a little while to play itself out. I think most people doing their taxes for 2018 had no idea what to expect. As they begin to recognize, "Oh, gee, I used to itemize but I didn't this time." It may be that actually it's 2019 and 2020 that we see the effects really play out.

So I think it's really worrisome. There's a lot of critiques that one can make of the way the charitable deduction has been implemented. Why should people have higher tax rates? Get more tax benefits for a contribution of $100? Lots of legitimate questions. But in general, I personally believe that it is a good thing from a policy perspective to incent people to be charitable because our nonprofit sector in this country is, as we said at the outset, a source of great strength and we want to make sure that we're supporting it.

Brokamp: One strategy the tax experts are recommending is that if the amount you give in a single year isn't enough to be able to result in a deduction, to bunch your contributions so you give two or three years' worth in one year.

Now if you want to do that, but you don't necessarily want to give the money to the charity in that year, one way to do that is through a donor-advised fund.

Buchanan: Exactly.

Brokamp: These things are becoming more and more popular, so I thought maybe we should talk a little bit about those. Why don't you explain what a donor-advised fund is?

Buchanan: You did a good job there. A donor-advised fund could be established at your local community foundation or there are also national providers. Fidelity Charitable is the biggest. Schwab. Vanguard. It makes things really easy. You put $10,000 -- the minimum range is often as low as $5,000 -- into a donor-advised fund at one of these donor-advised fund providers and then basically with a click of a button you can direct your contributions.

You get that deduction when you make the initial contribution to the donor-advised fund, which is technically a nonprofit charitable organization; even though it may take a little while before the gift gets to the operating nonprofits you want to support. This is why there's been a lot of controversy surrounding donor-advised funds and critics who suggest that these funds are just warehousing charitable dollars that should be going to operating nonprofits.

Now, it's actually kind of tricky because we don't really know what would have otherwise happened. We don't know the counterfactual. So to the extent that donor-advised funds on the higher side are replacing what would have been charitable foundations, it may be that it's actually resulting in more money out the door to operating nonprofits because DAFs pay out at an average of about 20% a year, whereas most foundations pay out close to the mandated minimum of 5%.

To the extent that the rise in DAFs is replacing what would have otherwise been straight checkbook-giving out to an operating nonprofit, then the critics would be right. But to the extent that it is actually making giving more convenient and leading people to give who wouldn't have [given] otherwise or [even] give more; well, then there's that, as well. We really don't know, but my view is that from a donor perspective, a DAF can be a really convenient way to do your giving.

And if you're looking to direct it yourself and you don't need a lot of support, then one of the big gift funds is a good option. If, on the other hand, you really want some support in your community, community foundations are a wonderful and I think underappreciated group of institutions in this country.

There are about 800 of them. They're in most communities with some degree of population and they have a staff whose job it is to help you think through [what your goals are and, given those goals, what nonprofits are effective]. They can help guide you through that decision making, which I think is a great benefit. Some community foundations are very well known and others, I think, are probably underappreciated for all of the value that they can bring to individual donors.

Brokamp: Just as an illustration of how big they've become, Fidelity Charitable now takes in more donations than any charity in the U.S.

Buchanan: Correct.

Brokamp: It surpassed the United Way. Just so people understand the details, you put the money in and you sort of operate it like a 401(k), because you choose the investments and then you eventually decide who gets it and when they get it.

Now some do put limits. I think with Fidelity you have to make a contribution every three years. Each has their own rules, but that is part of the criticism, is that people put money in and then maybe the charities don't see that money for a long time.

Buchanan: Right. Most of the major DAF providers and certainly the bulk of the community foundations, as far as I know, do have policies that prevent you from having a dormant account. I think the question is how that is defined and for how long the money can be there.

There are folks like Ray Madoff, who's a professor at Boston College Law School, who's been campaigning for some kind of limit on DAFs. They have to spend that within 10 years, for example; whereas, the community foundation and national gift fund folks say, "What are you talking about? The payout is actually pretty high at 20% plus and people should have the ability to make these decisions about the lifespan of their DAFs themselves."