The trouble with donor-advised funds

This is not the time to be holding onto money that will eventually go to charity.Needs are urgent: Globally, about one in 10 people remain extremely poor. In the US, the environment, immigrants, civil rights, reproductive freedoms and democracy itself face threats from the Trump administration. Meantime, it’s not hard to identify standout nonprofits.Yet an estimated $78 billion --$78 billion! -- sits in donor-advised funds, which are tax-advantaged accounts designated to be used, someday, for charity. The National Philanthropic Trust reports that in 2016 there were 269,180 DAFs in the US and that the average DAF holds $235,727.Most Americans are likely unaware of donor-advised funds, which are the fastest-growing sector of philanthropy. The biggest “charity” in the US last year, according to the Chronicle of Philanthropy, was not the United Way or the Salvation Army but Fidelity Charitable, the not-for-profit arm of the mutual fund company, where about 150,000 donors have DAFs.DAFs are also the single biggest reason for the explosive growth of the Silicon Valley Community Foundation, which is holding billions of dollars, mostly for well-to-do techies. I've written a long profile of the foundation that was published last week by the Stanford Social Innovation Review.Here’s how my story begins:

Silicon Valley technology has been unkind to traditional middlemen. Streaming music punished the record industry. Netflix killed video stores. Life has become harder for intermediaries such as travel agents and stockbrokers.So it is perplexing that when it comes to philanthropy, Silicon Valley has given birth to an intermediary that has rapidly grown into one of the world’s biggest foundations. The Silicon Valley Community Foundation (SVCF), which was formed 10 years ago by the merger of two smaller community foundations, connects the region’s wealthy donors to nonprofit organizations that they want to support, around the corner and around the world.With assets under management of more than $8.2 billion, the Silicon Valley Community Foundation last year made more than 108,000 grants valued at $1.3 billion, pushing more money out the door than the Ford, Rockefeller, Hewlett, or Packard foundations—more, indeed, than any foundation in the United States, except for the Bill & Melinda Gates Foundation.

The numbers are eye-popping. But if you read the story (and, of course, I hope you will), you will learn that there is less to the Silicon Valley Community Foundation (SVCF) than meets the eye. Of that $1.3bn in grants, only $19.2m came out of the foundation’s own coffers. The rest came from DAFs.A bit of explanation about donor-advised funds, for the untutored. DAFS function as a rest stop for charity dollars that depend upon a well-understood legal fiction: By law, they are controlled by the foundation, but in practice, donors decide how and when to give the money to charity. The result is, donors can deposit funds in a DAF, take an immediate tax donation and give the money away later, or pass it on to their heirs. (They cannot get the money back, of course.) The tax benefits are especially alluring for donors who transfer appreciated stock into a DAF because they avoid paying capital gains tax. This is why the accounts have special appeal in Silicon Valley, where entrepreneurs and venture capitalists who realize substantial gains from an IPO can avoid a whopping tax bill. Facebook’s Mark Zuckerberg had a $1bn DAF at the SVCF; his colleague Sheryl Sandberg also manages her charitable giving through a DAF. Setting up a DAF also gives them time to think through their substantial philanthropy.DAFs can be parked at community foundations, religious organizations, politically-oriented nonprofits (like Donors Trust, which appeals to conservatives), investment banks or at the multi-billion dollar charitable arms of asset managers like Fidelity, Vanguard and Schwab. Once money goes into a DAF, few requirements are imposed on the accounts, and donations can be made anonymously; private foundations, by contrast, are obliged to give away about five percent of their assets each year.Ray Madoff, a Boston College law professor and frequent DAF critic, and philanthropist Lewis Cullman wrote last year in the New York Review of Books that donor-advised funds “give donors all of the tax benefits of charitable giving while imposing no obligation that the money be put to active charitable use.” Nine of 10 donors surveyed by Fidelity said the tax benefit was the main reason they opened a DAF, The Economist reported.By coincidence, while reporting on the SVCF, I was invited to a presentation about DAFs by one of the big commercial providers. (Because I didn’t identify myself as a reporter, I won’t name the provider.) The saleswoman -- let’s call her Mary -- called donor-advised accounts “a win-win for everyone” because donors enjoy tax benefits and charities receive more funds, as assets appreciate over time. Her company, she said, can establish DAFs with donations of real estate or art--one must wonder about how rigorously these assets are evaluated--as well as cash. She recommended starting a DAF with appreciated stock to maximize the tax benefits.“I love to say--let’s disinherit the IRS,” she said.DAFs are a winner for the commercial providers, too, because they generate administrative fees, which are typically 0.3 to 0.6 percent of assets, as well as the investment fees generated by the products in which DAFs are invested. Unsurprisingly, for-profit Fidelity, Schwab and Vanguard manage the assets held by their charitable arms.The DAF providers, whether at a financial services firm or a community foundation, provide administrative and bookkeeping services to account holders, cutting checks to charities and tallying up annual donations. They vet grantees to make sure they are US-registered tax exempt charities. What they don’t do is provide advice on giving.Marie put it this way: “We try to stay neutral, and be Switzerland.”Emmett Carson, the chief executive of the Silicon Valley Community Foundation, told me much the same thing, rejecting the claim that some causes are more urgent than others. “Philanthropy is intensely personal,” Carson told me. “The fact that I think housing and transportation are critically important, does that mean hospitals aren’t important? Does that mean the arts aren’t important?” The presumption is that the customer is always right.

Misaligned incentives

Unfortunately, DAFS create incentives for providers to hoard, rather than distribute charitable dollars. Commercial providers and community foundations generate income from DAF fees, so the more assets they have under management, the more money they have to pay staff, fund operations and the like.Mary, the DAF saleslady, told me the only requirement for keeping a DAF alive is to make a contribution of at least $50 every five years. "If you make the $50 grant, we leave you alone for another five years," she promised.DAF advocates say their payout rates are higher than private foundations. That may be, but it’s hard to know because their accounting is murky. (See this blogpost about Fidelity Charitable by DAF critic Alan Cantor.) Among other things, “donations” from one DAF to another count as part of the payout. At the SVCF, for example, one DAF account holder moved moved $25 million to a DAF at Goldman Sachs, which the SVCF counted as “grantmaking.” That’s daffy.What’s to be done? A simple reform would be to require that funds deposited in a DAF be distributed to operating charities (and not to other DAFs) with a specified time frame, say, five or 10 years. Needless to say, commercial DAF providers don’t like that idea.As for the Silicon Valley Community Foundation, Eric Nee, the managing editor of the Stanford Social Innovation Review, argues that without a geographic focus, the concept of a community foundation begins to lose its meaning. Nee writes:

Community foundations need to reaffirm their unique role, and nowhere is there a greater need to do that than in Silicon Valley, a place of tremendous wealth but also extensive poverty. Nearly one-third of residents rely on public or private assistance to make ends meet. The cost of housing is sky-high, and public transportation is woefully inadequate.It’s a siren’s song for community foundations to go after donors with little regard as to what that money will be used for or where it will go. Instead, community foundations should focus on what they do best and put “community” first.

Or, as a foundation executive I know said about the SVCF: "It’s not that they’re doing anything wrong … but they’re just not doing much right in a place that needs a lot of good to be done."