It seems as though every week there is a story in the media about the popularity of donor-advised funds (DAFs). The scale of money flowing into DAFs has made them one of the most popular charitable giving vehicles in the United States.
One reason why donors (and their advisors) like DAFs so much is the ease of creating and funding them. Often, a DAF is used during a high-income year (perhaps resulting from the sale of a closely held business) to maximize a potential charitable deduction during the same tax year, since the fund can be created with a sponsor very quickly. Frequently viewed as an alternative to the traditional private (non-operating) foundation, a DAF is pitched as providing an easy mechanism for charitable grantmaking without the administrative burden that accompanies a foundation. In further contrast to the private foundation, DAFs are under no legal requirement to make grants in any given time frame (i.e., no activity requirement), nor are they required to disburse a minimum annual monetary amount (i.e., no 5% annual distribution rule).
However, while it may be a relatively quick and easy process to stand up a DAF, clients and their advisors often fail to think through what will happen to the fund when the donor-client is unable to personally manage the account anymore. Additionally, most DAF sponsors impose minimum activity policies that donor-clients may not be fully aware of.
Choosing an Exit Option
Here are some of the options available to clients when planning for their exit from a DAF.
Named successor(s). One of the most popular exit options is for the DAF creator to name a successor to serve in their place after they die. This is often a surviving spouse or child. However, different DAF sponsors treat the naming of multiple successors in slightly different manners. Some allow for only a set number of successors (from two to 10), while others require the successors to be within one generation of the original creator. Additionally, some sponsors require a DAF to be split into different shares, with each successor given their own individual DAF to control going forward. Once a successor advisor is named and appointed, they would carry on with the same advisor privileges the creator enjoyed during their life.
Fixed immediate payout to named charities. Another common option permitted by most DAF sponsors is for the DAF creator to name specific individual 501(c)(3) organizations to receive outright grants from the fund upon the death of the fund creator. Similar to a beneficiary designation form available for financial accounts, a DAF creator can mandate that set percentages of the DAF assets be distributed to named charities. So long as the named charities are in existence and maintain their 501(c)(3) status, they can receive these final grants from the DAF. Once the DAF is depleted of funds, it is extinguished.
Endowment option. Another exit strategy available to DAF creators is what is sometimes called the endowment option. Similar to the fixed immediate payout options above, the endowment option allows for a DAF to distribute a smaller annual percentage to selected charities with the corpus of the DAF reserved and invested in perpetuity. This option usually carries with it the requirement that the DAF stay funded above a minimum set level (e.g.,$100,000) and often requires some minimum percentage of annual payout (e.g., 5%) to charitable beneficiaries. The named beneficiaries would also need to maintain the 501(c)(3) status for the duration. Similar to the individual endowment option, some DAF providers allow creators to transfer remaining funds to sponsor-controlled funds that contribute to a broad set of charitable beneficiaries (e.g., a fund that supports education). With this option, the choice of respective charitable grantees rests with the controlling board of the DAF sponsor.
Minimum Activity to Avoid Abandonment
Donors and their advisors should be aware of minimum activity policies as they manage the DAF over time.
It is true that current law does not require any minimum amount of activity by a DAF for it to remain viable. However, practically every DAF sponsor (usually community foundations or financial institutions) requires each DAF fund to maintain some amount of minimal activity. The time frame varies, but most sponsors mandate at least one charitable grant to be made every two to three years.
Failure to maintain this minimal activity can result in a wide range of outcomes. A common outcome is a forced transmission of a charitable grant with a dollar value ranging from $250 to 5% of the fund's value. Failure to make contact with the DAF creator may trigger whichever exit option is on file. If there is no viable exit option, the default path is for the funds to come under the control of the governing body of the DAF-sponsoring organization.
Thoughtful and efficient charitable giving can provide enormous satisfaction to clients and their families over the course of many years. But, as with any giving vehicle, DAFs require some care and feeding to ensure they function properly and carry forward into the future according to the wishes of those who create and fund them.
LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. This offering is provided exclusively through Wealth Management at Seacoast National Bank.