Is the New Way to Give a Better Way to Give?

Donor-advised funds are gaining popularity, but charities may be losing out.

Most people think of charitable donations as happening in one of two ways. In one scenario, people decide how much they want to donate, then select a charity that will be the recipient of the funds. In the other scenario—one only available to the wealthy—a donor can take their money and set up their own foundation, transfer money over to it, have it grow, and then give away money over time, perhaps in perpetuity.

There’s also a third way that combines the first two approaches: It’s called a donor-advised fund, and it lets even small-scale givers put money into an account, let it mature, and then disburse it gradually. Donor-advised funds are becoming such a popular option that in 2015, the Fidelity Charitable Gift Fund, the donor-advised fund set up by the financial firm Fidelity Investments, overtook the United Way to become the largest recipient of charitable funds in the United States.

This development, though, is worrying to some. One leading critic is Ray Madoff, the director of the Boston College Law School Forum on Philanthropy. Last year, she called donor-advised funds “a bad deal for American society” in an essay she co-authored with the New York–based philanthropist Lewis Cullman in The New York Review of Books. The funds are, Madoff and Cullman went on to argue, not just inserting a middleman into the charitable-giving process, but they are also potentially slowing the regular streams of money going from givers to nonprofits.

To understand why a way of giving money to charity could be so controversial, it helps to understand how exactly it works. Donor-advised funds could best be described as a waiting room for charitable donations. People who wish to give money to charity deposit the money in an account with a donor-advised fund, where they can elect a way to invest it, or, if they place enough money in the account (at Schwab Charitable, for instance, it’s $250,000), they can choose instead to have an investment advisor manage their portfolio. In return, they receive an immediate deduction on their taxes for the amount they have “donated” by depositing into the fund, and when they are ready to make their donation (which could be years in the future), they alert the fund, and their money is disbursed to the cause of their choosing. Once the money’s in the account, it can’t be returned to the donor—it then technically belongs to the donor-advised fund.

So why use donor-advised funds instead of giving to a charity directly? For one thing, they allow ordinary people to grow their money over time, and give it to charity as a philanthropist would, like a DIY Bill Gates. Another reason: Perhaps the account holder just wants the tax deduction, and doesn’t feel like selecting a charity at the moment. These funds allow people who earn more money in one year than another to time their deduction, depositing money in the donor-advised fund in years when their earnings permit them to receive a greater tax benefit, and then donating the money to charities over a period of years. Those who are in favor of donor-advised funds suggest this incentivizes people to donate more than they otherwise would; detractors say it’s just another tax advantage for the wealthy.

While donor-advised funds date back to the Great Depression, they weren’t widely promoted by brokerage houses until the early 1990s, when Fidelity sought and obtained a ruling from the Internal Revenue Service that gave it permission to set up Fidelity Charitable. Soon, other financial services firms established similar funds.

According to the nonprofit National Philanthropic Trust, givers put $23.27 billion in donor-advised funds in 2016, a 7 percent increase from 2015 and an 18 percent increase from 2014. That money is spread out among a variety of funds: The Chronicle of Philanthropy’s 2016 survey listed six donor-advised funds in the top 10 charities ranked by donations, including Schwab Charitable, the Vanguard Charitable Endowment Program, and the Goldman Sachs Philanthropy Fund. (Such funds are more popular in the United States than in some other wealthy countries, perhaps because Americans give a greater percentage of their income to charity.)

Another appeal of these funds is that they allow aspiring philanthropists to get started with relatively small amounts of money. Schwab Charitable, for example, requires an initial donation of only $5,000; after that, future deposits (if there are any) can be as low as $500. This allows champions of donor-advised funds to argue that they result in a quasi-democratization of nonprofit foundations. Foundations are expensive to set up and administer, and experts generally say that unless donors are starting with at least $250,000, most would be better off putting money into a donor-advised fund. Since people can deposit more into those funds over time, they offer people who aren’t extremely wealthy a way to build up money in a tax-advantaged way, allowing them to give larger sums when they do finally sign the money over to charity.

But—and this is a big but—someone with a donor-advised account doesn’t actually need to order that the money get disbursed. It can remain invested with the donor-advised fund in perpetuity. This makes accounts with donor-advised funds distinct from foundations, which are required by law to give out 5 percent of their net investment assets on an annual basis. Compounding the issue: Tax laws incentivize donations to donor-advised funds, but don’t do the same thing for actually getting the money into the hands of an on-the-ground charitable organization; the giver gets the tax break in the year the money goes into the fund, not when it’s distributed to charity.

This makes donor-advised funds less than popular among many in the philanthropic community, who have come to believe that their deposits would otherwise be put to immediate use by a charity. “They’re becoming holding tanks for charitable dollars,” complains Alan Cantor, a philanthropic consultant based in New Hampshire. “The money goes out at a very leisurely pace.”

Defenders of the funds dispute that, pointing out that approximately 20 percent of money in the funds is disbursed annually—higher than the 5 percent that foundations are legally required to give out. If people want some flexibility in choosing where their money goes, what’s the harm? “They provide a way for people who want to give away money but don’t know precisely who they want to give it to a chance to make their decisions about how to get the tax benefits in the year they which they get the money, and then specify where the money is going in a later year,” says Joel Fleishman, the director of the Center for Strategic Philanthropy and Civil Society at Duke University.

But there’s another problem with this model, at least from the perspective of charities: When money arrives from a donor-advised fund, a charity often doesn’t know who actually made the donation. This makes philanthropic organizations’ jobs harder, because they can’t cultivate repeat donations. On the other hand, this can be a lure to the giver: For smaller-scale donors, it means fewer solicitations (via both email and physical letters), and for big-money donors, it’s one fewer organization hounding them for money.

The anonymity that donor-advised funds provide is problematic on another level too. It allows givers to obscure their identities. For example, according to The Daily Beast, Project Veritas, the right-wing organization whose mission is to reveal alleged left-wing media bias, received $381,505 from Donors Trust, the right-wing donor-advised fund notoriously supported by the Koch family, and $52,050 between 2011 and 2013 from the Fidelity Charitable Gift Fund. The white nationalist Richard Spencer’s nonprofit, the National Policy Institute, also received donor-advised–fund money prior to the IRS’s revocation of its tax-exempt status. “There’s no direct line between a controversial donor and a controversial cause,” Cantor says.

Yet some of these issues seem like they would not be hard to address. One way to prevent people from putting money into the account, taking advantage of the tax deduction, and then not getting around to distributing it would be to impose a deadline before which all deposits must be disbursed. But when former Michigan Representative Dave Camp introduced tax-overhaul legislation in 2014 that would have required that funds be distributed within a five-year period, the bill went nowhere because, at the time, tax reform did not have sufficient traction.

The problem of anonymity is tougher to solve. That’s because the way the tax code governs donor-advised funds, the money actually belongs to the fund once the donor turns it over, with an agreement that the fund will honor the donor’s wishes as long as the ultimate beneficiary is an officially recognized charity. But as a result, the gifted money is reported as coming from the fund, and if donors don’t want to identify themselves, they don’t have to.

It’d be nice if the government could at least step in to ensure that charities know where they’re getting their money from. Donor-advised funds are not likely to go away anytime soon—a study released by Fidelity Charitable last year found that donors under the age of 50 are much more likely than those over 50 to use donor-advised funds—so tending to problems like these will only become more important as this way of giving gains popularity.