Why Americans Should Cheer the Use of Donor-Advised Funds

Why Americans Should Cheer the Use of Donor-Advised Funds

Feb 04, 2021 Elizabeth McGuigan

When It Comes to DAFs, Definitions Matter

Philanthropy’s critics are on the rise. Groups such as Patriotic Millionaires and Half My DAF are calling for regulatory changes that could chill charitable giving in America at the expense of our communities. The “Initiative to Accelerate Charitable Giving” is one such proposal that deserves careful scrutiny.

A recent working paper by James Andreoni and Ray Madoff, “Calculating DAF Payout and What We Learn When We Do It Correctly,” examined donor-advised funds, or DAFs, with a laudable goal: to call for more charitable giving. However, the authors’ suggested road to increasing such giving would send lawmakers in the wrong direction.

To correct course, it is important to start with a complete and accurate definition of DAFs. Missing in Andreoni’s and Madoff’s working paper is a key fact:  By law, there is only one way that DAFs can be used—all contributions to them must be given to qualified charities. This dominant feature is why all Americans can cheer the growth and success of DAFs.

What Are DAFs?

DAFs are personal charitable giving accounts. Every American, of any income level, is free to create one of these charitable giving accounts, which are hosted by 501(c)(3) sponsoring organizations such as their local community foundation. By opening a DAF, a person has taken the first step toward becoming a charitable donor. Every dollar he or she puts into this account must be directed to a qualified charity and may not be withdrawn for other uses or transferred to a different type of non-charitable account. While the funds are legally controlled by the sponsoring organization, the donor directs his or her dollars to charities and advises how to invest the assets in the account.   

There are real and compelling benefits to creating a DAF. For example, the donor may claim a tax deduction for the amount put in. This is similar to the benefits of creating a charitable foundation or giving in myriad other ways. The charitable tax deduction was created to inspire exactly this behavior.  

A Misleading Definition

Andreoni and Madoff define DAFs as: “a form of charitable giving in which donors transfer their cash or property to a DAF sponsor, giving up legal ownership, but retaining ‘advisory privileges’ which allow the donor (or other designated advisor) to make decisions about the investment and disbursement of DAF assets.” That is clear enough, but then the authors claim: “DAFs operate in practice like a combination of a charitable investment, savings, and checking account.” 

However, DAFs do not operate as a savings account or a checking account, as these common bank accounts can be used for any purpose. Once funds are put into a DAF, they must be used for charitable giving only.

The authors appear to take issue with one of the main features that have helped DAFs to rise in popularity: Dollars in DAF accounts may be invested and could grow over time. In no way does this feature hurt charitable giving. All it means is that there will be more funding available for charitable organizations in the long run. In fact, this feature allows donors to be thoughtful and strategic in their giving, giving them the opportunity to choose when and how to distribute funds to charity based on their own goals and timeline.

Perhaps a donor wants to make a big impact by providing a large gift to a local charitable organization but is only able to put a small amount into a DAF each year. For example, a donor may wish to fund a new science lab for a local high school or to sponsor an annual scholarship for students in his or her town. These types of projects can’t be accomplished by smaller donations today—they require larger gifts. Since DAFs can appreciate over time, they allow the donor’s gift to grow until it reaches the amount needed to achieve his or her donation goal.

Unlike a savings or checking account, the donor cannot take the funds out of a DAF account and spend them on a new car or vacation. Remember, every dollar that goes into a DAF account—including the growth of those funds over time—must be distributed to a charity.

The value of this choice and the intent of the donor are fundamental to DAFs. According to Andreoni and Madoff, “the benefit of DAFs to the public is less certain as there are currently no regulations or time limits on when or how fast DAF funds must be disbursed to charities.” 

That is true because the donor gets to decide when that distribution is most advantageous to meeting his or her own giving goals. However, a larger gift over the long run may also be better for the intended charitable organization’s goals and mission as well. It’s important to understand that restrictions and limitations on charitable giving not only create roadblocks for donors, but could also harm the groups and people who benefit from charitable giving.

Either way, having the freedom to choose how, when, and to whom to donate does not mean these dollars are “resting” or “stockpiled,” as the authors suggest. All DAF dollars are charitable dollars, and many in the charitable sector have already pointed out that DAFs have a higher payout rate—about 20 percent—than the required 5 percent minimum for private foundations.

Why Does This Matter?

Before considering proposed changes to how DAFs are regulated, lawmakers must have an accurate, fundamental definition of DAFs and an understanding of the key role of donor intent.

Americans know the value of charitable giving, and they have demonstrated this many times during past national crises. DAFs are a crucial vehicle that make it easier for all Americans to support the groups and causes they believe in. They are paving the way for a continued democratization of charitable giving, and we should not put the brakes on their success.