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3 benefits and a drawback of using donor advised funds

September 20, 2021
A nonprofit employee happily works on a donor advised fund.

The world of grantmaking is complex, as it requires a lot of paperwork, tax information, and various other complicated tasks. This is especially true for grantmakers who wish to take part in making funds available to local and global nonprofit organizations. While it can be difficult, finding the best way to structure your grantmaking organization is incredibly important to support the causes you hold dear.

If you know the basics, you know there are multiple approaches to giving. A quickly growing and efficient approach is found in donor advised funds, or DAFs. A recent Donor Advised Fund Report cites the increasing number of individual donor advised funds across the country. Donors contributed $29.23 billion to these donor advised funds and used them to recommend $19.08 billion in grants to qualified charities. Charitable assets in donor advised funds totaled $110.01 billion, surpassing the $100 billion mark for the first time.

This guide will cover what donor advised funds are and what makes them so popular for foundations and donors. Let’s begin.

What are donor advised funds?

In the simplest of terms, donor advised funds are charitable investment accounts. They are typically managed by a tax-exempt organization like a nonprofit or a local community foundation. These funds are tax-preferenced, so the donor will receive the tax deduction for their contribution immediately, even though the funds are used at a later date.

Once the donor receives the tax acknowledgment, they are not in direct control of the use of their donations, though they can suggest potential charities and causes. Instead, the sponsoring organization acts as the grantmaker and decides the ultimate direction of the funding.

3 benefits and 1 drawback of donor advised funds

Part of the reason why donor advised funds are gaining such traction is that they provide your organization with a new stream of revenue. Here are three additional benefits and one drawback to donor advised funds:

Benefit 1: Operational costs are lower than private foundations.

The cost of operating a private foundation is significantly higher than the cost of managing a donor advised fund. These foundations must hire staff to handle their administrative work, and they must also form a board to hold meetings and record minutes. In addition, private foundations must file state and federal tax returns. They may face excise taxes on investment income, require an annual 5% distribution, and have lower limitations on tax deductibility.

Furthermore, foundations can take months to years to establish, and require a significant financial investment. On the other hand, donor advised funds can be set up almost immediately for a much lower cost.

Donor advised funds also tend to have a simpler structure, which helps families and community groups become grantmakers with more modest beginnings. This is great news especially for local nonprofits as these tend to be smaller organizations that are often more inclined to focus on local causes.

Benefit 2: A simpler method for donating appreciated assets.

Not all donors have liquid assets—they may also have stocks, real estate, and other appreciated assets that can be valuable to nonprofits. Although many nonprofits aren’t able to accept these assets, donor advised funds allow donors to give these assets to charitable organizations by liquidating them. Additionally, these assets can grow and gain value within the fund, tax-free. Donors benefit by having higher limits when donating those appreciated assets and nonprofits have a simpler donation transaction.

Benefit 3: International giving is more streamlined.

Although donors are interested in helping causes outside of the United States, making donations to charities outside of the country has its own challenges and restrictions. Because the US vets charities differently than many other countries, obtaining a tax deduction for a gift may be difficult. Donor advised funds are a charitable vehicle that can help eliminate some of those barriers and help ensure an impactful international giving experience for the donor.

Donors can create a donor advised fund with an organization that specifically works with global grantmaking, such as the Charities Aid Foundation of America. Organizations like these will step in to assist companies, foundations, and individuals to ease the complications of international giving. They will also conduct their own audit of international charities and perform other risk mitigation practices.

Drawback: Administrative responsibility falls on the grantmaker.

While donor advised funds provide many benefits for all involved parties, there are some trade-offs. Donors are able to receive their tax deduction immediately, but they must sign over some of the ability to choose their donation’s ultimate destination. The sponsoring organization or donor advised fund grantmaker, is given more control over donations and how they are administered.

Because grantmakers have more control over donations, they have an additional administrative burden. These organizations are responsible for establishing the overarching purpose of their donor advised fund and ensuring donors feel confident contributing to it. Vetting the nonprofits who receive gifts is also the responsibility of the grantmaker, in addition to paperwork and maintaining legal compliance. Additionally, many grantmakers measure gift-giving impact and organize annual reports for donors to guide future giving decisions.

Software for donor advised funds

The potential for donor advised funds is massive and there are many benefits to implementing them into your organization. While the drawback of administrative burden might give you pause, investing in a software solution can help you easily leverage donor advised funds.

For example, Bonterra Corporate Responsibility’s Disbursement solution will help you maintain donor records, process donations, issue tax receipts, and furnish reconciliation reports for your finance department. It will also provide a reporting portal so your NPOs can track their activity. And instead of paper checks, the money is issued monthly or quarterly by electronic funds transfer. This type of giving is slowly growing in popularity, so don’t let your fears stop you from reaping the benefits!

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