Key Takeaways
- Donor-advised funds (DAFs) can be set up in a matter of days — or even hours. Setting up a private foundation, however, takes time, since it involves establishing a legal entity.
- DAFs aren’t subject to required minimum distributions, so investments can grow tax-free indefinitely (subject to any rules of the sponsoring organization).
- With a private foundation, you and other board members retain full control over the investments and distributions.
If leaving a charitable legacy is important to you, you may be thinking about establishing a private foundation for managing your philanthropic activities. Private foundations can be highly effective but expensive to set up and operate. Donor-advised funds (DAFs) are popular alternatives but also have potential drawbacks.
Benefits of Using a Private Foundation or Donor-Advised Fund
Channeling your contributions through a private foundation or DAF provides unique benefits.
Not only do you gain immediate charitable tax deductions, but you're also afforded the flexibility of not having to pinpoint specific beneficiaries or rush contributions. This gives you more time to research potential recipients or change the organizations you support from year to year.
These vehicles also allow you to involve your family in your charitable endeavors. You can name family members to the board of a private foundation or even hire loved ones to manage it. Many DAFs allow you to designate a successor advisor.
Private Foundations vs. Donor-Advised Funds
A private foundation is a charitable organization, typically structured as a trust or corporation and designed to accept donations from a small group of people, such as you and your family. Private foundations usually make grants to other charitable organizations rather than provide philanthropic services themselves.
A DAF is an investment account controlled by a sponsoring organization — usually a public charity or community foundation — and often managed by an investment firm. The fund accepts tax-deductible contributions from investors, who advise the fund on how their charitable dollars should be spent.
Pros and Cons
DAFs generally can be set up in a matter of days — or even hours. Setting up a private foundation, however, takes time, since it involves establishing a legal entity.
A DAF can be a desirable option if:
- You have charitable inclinations and are looking to maximize the tax benefits.
- You want to make a tax-deductible charitable contribution immediately but still need some time to determine which charities you’d like to support with grant recommendations.
- You are considering a concentrated giving strategy with several years’ worth of contributions but would like to maintain gifting over time for specific charities.
- You are looking for a way to contribute non-cash complex or illiquid assets to charities that cannot take those types of donations.
Another advantage of DAFs is that they’re inexpensive (or free) to create, and minimum initial contributions can be as low as $5,000. In contrast, starting a private foundation involves significant legal and accounting fees. Foundations also require much larger initial contributions — typically hundreds of thousands or even millions of dollars — to justify their start-up and ongoing administrative expenses.
Here are other ways the two vehicles compare:
- Operating Expenses
DAFs typically charge management and investment fees of around 1% to 2% of your account balance. Managing a private foundation is much more expensive since you’ll need to appoint a board, hold periodic meetings, keep minutes, file separate tax returns, and incur ongoing legal and accounting costs, in addition to paying investment fees. You’ll also need to hire a staff or engage a third-party administrator and pay an excise tax on net investment income (currently 1.39%).
- Distribution Requirements
DAFs aren’t subject to required minimum distributions, so investments can grow tax-free indefinitely (subject to any rules of the sponsoring organization). But private foundations must distribute at least 5% of their net market value each year.
- Charitable Recipients
Distributions from DAFs must be made to public charities. Private foundations can make grants to a wider range of charitable recipients, including individuals (subject to certain restrictions).
- Tax Deductibility
Cash contributions to DAFs are tax deductible up to 60% of the donor’s adjusted gross income (AGI), while non-cash contributions are generally deductible up to 30% of AGI. For private foundations, the deduction limits are 30% and 20%, respectively. Typically, you can deduct the market value of appreciated assets donated to a DAF. Deductions for donations to foundations are limited to your cost basis (except for publicly traded stock).
- Privacy
DAFs are permitted to accept donations privately, so it’s possible for contributors to remain anonymous. Private foundations must publicly disclose the names of donors who give more than $5,000.
- Control
This is an area where private foundations have a clear advantage. You and other board members retain full control over the foundation’s investments and distributions. DAF contributions become the sponsor’s property, and your role in managing investments and distributions is strictly advisory. Practically speaking, however, sponsors almost always follow contributors’ advice.
Establishing Your Philanthropic Strategy
The right charitable giving vehicle for you depends on many factors, including your financial resources, the charities you wish to support, and the level of control you desire. Eide Bailly’s experienced advisors can help you design a philanthropic strategy that meets your needs.
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