Private foundations and donor-advised funds: Debunking three myths

If you’ve been involved with charitable giving for a few years, you’ve no doubt become familiar with both private foundations and donor-advised funds and their popularity as charitable giving tools. As is often the case with tax and estate planning-related topics, the differences between private foundations and donor-advised funds are sometimes the subject of confusion and misunderstanding.

As you work with your advisors and the team at the community foundation to establish your immediate and long-term charitable giving plans, take a few minutes to check out how to debunk these three common myths. 

Myth #1: Donor-advised funds are all the same and only private foundations can be customized

Private foundations will always differ from donor-advised funds in important ways not only because of their status as separate legal entities and the deductibility rules for gifts to these entities but also because of the opportunities to customize governance. But it is a mistake to think that a donor-advised fund is a cookie-cutter vehicle. Indeed, “donor-advised fund” is simply a term used to specify the structure of a fund and its relationship with a sponsoring organization such as a community foundation. The donor-advised fund vehicle itself is extremely flexible. 

–Donor-advised funds are popular because they allow a donor to make a tax-deductible transfer of cash or marketable securities that is immediately eligible for a charitable deduction. The donor can recommend gifts to favorite charities from the fund when the time is right. 

–A donor-advised fund at the community foundation is frequently a more effective choice than a donor-advised fund offered through a brokerage firm (such as Fidelity or Schwab). That’s because, at a community foundation, you and your family are part of a community of giving and have opportunities to collaborate with other donors who share similar interests. 

–PdNCF can work with you and your family on a charitable giving plan that extends for multiple future generations. That is because the team at the community foundation supports your family in strategic grant-making, family philanthropy, and opportunities to gain deep knowledge about local issues and nonprofits making a difference. 

As you explore the many opportunities to deepen your work with the community foundation, consider the unique mix of flexibility and services available to you and your family when you establish a donor-advised fund.

Myth #2: Deciding whether to establish a donor-advised fund or a private foundation mostly depends on size

The size of a donor-advised fund, like the size of a private foundation, is unlimited. The United States’ largest private foundations are valued well into the billions of dollars. (Information about private foundations, ironically, is not so private. The Internal Revenue Service provides public access to private foundations’ Form 990 tax returns. That is not the case for individual donor-advised funds.)

Similarly, donor-advised funds are not subject to an upper limit. Although information on the asset size of individual donor-advised funds is not publicly available, anecdotal information indicates that some donor-advised funds' assets may total in the billions of dollars. 

Indeed, a donor-advised fund of any size can be an effective alternative to a private foundation, thanks to fewer expenses to establish and maintain, maximum tax benefits (higher deductibility limitations and fair market valuation for contributing hard-to-value assets), no excise taxes, and confidentiality (including the ability to grant anonymously to charities).

 The net-net here is that the decision whether to establish a donor-advised fund or a private foundation–or both–is much less of a function of size than it is other factors that are more closely tied to the objectives a donor is trying to achieve. 

Myth #3: Donor-advised funds and private foundations are mutually exclusive

Many philanthropists and their advisors are aware of the many benefits of using both a donor-advised fund and a private foundation to accomplish their charitable goals. For example:

–Donor-advised funds can help meet the need for anonymity in certain grants, which is typically difficult using a private foundation on its own.

–A donor-advised fund can receive a family’s gifts of highly-appreciated, nonmarketable assets such as closely-held stock and real estate, and benefit from favorable tax deduction rules not available for gifts to a private foundation.

–An integrated donor-advised fund and private foundation approach can help a family balance and diversify its investment and distribution strategies to ensure that giving to important causes remains steady even in market downturns.

Some private foundations are even considering transferring their assets to a donor-advised fund at the community foundation to carry on the foundation’s mission. Terminating a private foundation and consolidating giving through a donor-advised fund is sometimes the best alternative for a family when the day-to-day management and administration of the private foundation has become more time-consuming than expected and is taking time and focus away from nonprofits, the community, and making grants. In addition, some families find that the tax rules related to investments, distributions, and “self-dealing” have become harder to navigate and are perhaps even preventing the family from maximizing tax benefits of charitable giving. Finally, the administrative load of managing a private foundation sometimes becomes overwhelming, especially if the family members who handled these functions initially have retired, passed away, or simply become busy with other projects.

Evaluating options for focusing your philanthropy

If you’ve been giving to favorite charities for many years, it will not surprise you to learn that most donors are interested in deepening and focusing their impact as they maintain the frequent and total amount of giving. 

Focusing on impact is hard, but it’s easier when you work with the community foundation and follow best practices for making grants to favorite causes. The community foundation’s expertise can be invaluable to you and your family as you pursue your charitable goals.

Here are three suggestions for refining your giving strategies to support your favorite causes.

Educate yourself. 

Learn about best practices that are emerging in the growing field of philanthropy. You can discover various philosophies that can drive charitable giving and gain insights from examples of what other philanthropists report has worked well and not so well. Working with the community foundation team is an excellent way to gain access to the most up-to-date research and resources on making an impact, including ways to make decisions with your partner or involve your family.  

Follow your heart.

Your charitable giving is going to be most effective when you support the causes you truly care about. You’ll be more committed and better able to focus on impact if you experience the psychological rewards of providing financial support to organizations that align with your personal beliefs about how the quality of life can improve for people in the community. 

Seek information.

Information about nonprofit organizations is widely available to you through several online sources, including being able to access nonprofit organizations’ tax returns to see detailed financial data. As you do your online research, consult the team at the community foundation. We are happy to interpret the information available online and provide important context for the meaning of that information as it relates to the actual work of the nonprofit organization and the ways you are supporting it. 

Go deeper

Many donors are continuing to support relief efforts in Ukraine, as well as exploring how to help the victims of the earthquakes in Turkey and Syria. The team at the community foundation is happy to help you balance your desire to meet the most critical needs in our local community while also supporting international relief efforts. Please reach out anytime. Our team is also happy to share insights about what's trending in philanthropy overall, including best practices in disaster giving. We are here to help you achieve your short-term and long-term charitable goals and work with you and your advisors to do so in the most tax-effective manner.

This newsletter is provided for informational purposes only. It is not intended as legal, accounting, or financial planning advice.