This is the third article in a six-part series on charitable giving. In this article we explore when a charitable mission is best met by contributing to a donor advised fund.

In our last article we focused on our hypothetical clients, the Howards. The Howards are business owners that have three children, one of whom, their son James, is in remission from a rare type of childhood cancer. The Howards’ charitable mission is to show gratitude to the hospital that cured James and to fight his disease, pediatric neuroblastoma. That mission could be met by making direct gifts to the hospital, which is what the Howards chose to do.

But the Howards just received a very lucrative offer to sell their business. The sale will result in sufficient wealth to allow the Howards to fund their charitable mission. The transaction will also generate significant tax liabilities. To meet their goals, and alleviate their pain, the Howards would like to make a material charitable gift before the end of the year.

The challenge is that after meeting with the hospital board, the Howards have learned that because that the hospital has so few childhood cancer patients each year, a gift of that magnitude will practically need to be used for purposes other than the eradication and treatment of childhood cancer. Also, as the Howards reflect on their conversation with the board, they have become less comfortable that the hospital has an effective plan to use these resources to fight childhood cancer.

What the Howards would like to do is give the hospital less money annually over a longer period of time to “test out” the impact of their giving. If their suspicions are correct that the hospital cannot make a meaningful impact on childhood cancer, the Howards could then divert their future giving accordingly. But as they think about giving in the “right way,” the Howards are concerned about getting a current tax deduction when it will have the most economic impact, given the sale of their business.

Why Use a Donor Advised Fund?

A donor advised fund is a charitable giving vehicle administered by a public charity. While any public charity can create donor advised funds, typically they are found either as part of a community based foundation (the Greater Milwaukee Foundation, for example) or provided as an offering of the charitable arm of a large financial services company (Fidelity, Vanguard, etc.).

The best practical description of a donor advised fund is a repository for future giving. In other words, the money in the account is not meant for the underlying charity but is rather to be later used for other charities.

The reason donors create donor advised funds is to meet the charitable goals of people like the Howards; they would like to decouple the timing of tax deductible giving from the actual grants to the charity you want to donate to.

Logistically, the Howards would create the donor advised fund to which they would make tax deductible contributions. The Howards get the benefit of the tax deduction in the year they contribute assets to the fund, not the year the fund contributes assets to the charity. Those fund assets are then invested and grow income tax free. Then, at the direction of the Howards, their fund makes contributions to the hospital (or other public charities of their choice).

Tax Treatment of Donor Advised Funds

Under the code, donor advised funds are public charities. Therefore, the same limitations and restrictions highlighted in the last article—about direct giving—apply to contributions to donor advised funds.

Having said that, from a practical perspective, because donors tend to make larger “event based” contributions to donor advised funds, these limitations should be closely scrutinized to ensure that the main goal of using this technique (timing of tax deduction) is met.

Limitations of Donor Advised Funds

In sampling the internet articles that analyze donor advised funds, a lot of verbiage is spent on the imperfect control the donor has over charitable contributions. From a legal standpoint, it is the charity sponsoring the fund (e.g., The Greater Milwaukee Foundation) that has ultimate control over the recipient of the contributions. The donor has the right to advise on who those charities are. Authors often highlight the difference between ultimate donor control in direct giving or in a private foundation from this “lesser” advisory role in a donor advised fund. S

imply put, in practice, that is nonsense. Donor advised funds generate revenue by operating as promised; the donor can contribute now for later charitable impact. If the donor advised fund does not deliver on that promise, it will not receive future contributions and will soon be liquidated. There are no practical control differences between donor advised funds and more direct forms of giving. And of course in the case of the Howards, they would be creating and controlling the donor-advised fund themselves.

But there are still reasons donors like the Howards would use other giving techniques. As highlighted in the last article, when a direct gift can perfectly meet their charitable mission, it is the most effective and simplest giving technique. And when the Howards’ charitable mission cannot be met by giving to public charities, then a private foundation becomes the optimal choice. Those situations are the focus of our next article.

Charitable Giving Series

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Start with “Why”: Choosing the Right Approach to Charitable Giving

Given the significant interest in philanthropy, it’s no surprise that the internet has plenty of questionable material on the subject—advising and educating (and often advocating) about direct giving vs. donor-advised funds vs. private foundations. These articles focus on the how, including costs, control, tax benefits, ongoing burden and legacy.

READ MORE about choosing the right approach for charitable giving.
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Direct Giving: Choosing the Right Charitable Giving Approach

This article continues a our six-part series on charitable giving. In the first installment , we explained the importance of establishing the why before focusing on the how. Now, we’ll take our first step into the how, with a discussion on the simplest method: direct giving.

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Using Donor Advised Funds to Make a Philanthropic Impact

This is the third article in a six-part series on charitable giving. In this article we explore when a charitable mission is best met by contributing to a donor advised fund.

READ MORE more about using donor advised funds to make a philanthropic impact.
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Using Private Foundations to Build a Family Culture of Philanthropy

This is part four of our six-part series on charitable giving. In this article, we focus on why people use private foundations to execute their charitable mission.

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Charitable Giving Designed to Enhance Non-Charitable Goals: Understanding Testamentary Charitable Lead Trusts

This is the fifth part of a six-part series on charitable giving. The previous articles all focused on the Howards, a couple that had a charitable mission inspired by their son James’ childhood cancer. The Howards were prototypical charitable donors; their philanthropy was driven by a cause, and they used the tax code to enhance their impact.

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by Joe Maier

Joe has extensive experience helping high‐net worth individuals, family offices, business owners and corporate executives meet their wealth and legacy goals. His areas of specific interest and skill include business succession planning, financial and estate planning, and wealth transfer strategies.

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by Bob Schneider

Bob Schneider specializes in providing clients with the educational information and tools necessary to make informed decisions regarding their financial planning goals. He uses his financial planning experience to help individuals and families plan for and enjoy their retirement years.

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