Family Foundation or Donor-Advised Fund; Which One is Right for You?
The St. Louis community is often referred to as one of the most charitable in the United States, and rightfully so. We often rank in the top ten of large metropolitan areas, which is one more reason to be proud of our region.
Most of us are “checkbook” philanthropists, meaning we simply write a check or pull out a credit card when it’s time to give. We’re moved to give by stories we hear or when friends and family ask us to support a cause. We do it without much thought other than knowing it’s the right thing to do and it makes us feel good. But, is there a better way? Can you be more strategic and effective as a philanthropist?
A big step towards answering those questions is to consider how you give. Is a checkbook or credit card the right tool for your philanthropy? While this approach has a place in most households, if you want to enjoy significant tax benefits and become more organized about your giving, it’s time to consider setting up a donor-advised fund (DAF) or a family foundation. As a philanthropy advisor, YouthBridge Community Foundation helps families choose the best option for their charitable goals.
A DAF and family foundation can be viewed as a “charitable giving account” intended to make donating easier. Both start with an initial gift into an account and at any point throughout the year, you may award grants to the charitable organization(s) of your choice. Despite similarities each has distinct advantages and disadvantages. Our clients often ask which one is right for them and I answer truthfully, it depends; maybe both!
Starting a DAF involves opening an account at a sponsoring organization, like YouthBridge Community Foundation, filling out a simple application, and making a donation. That’s it, you’re done – you now have a DAF. The process is quick, simple and inexpensive.
In contrast, setting up a family foundation is more complex, time consuming and costly. A family foundation is set up as a charitable corporation or trust and it will need to be submitted to the IRS to obtain tax exempt status. Additionally, you will appoint board members or trustees. The process is not quick, and it can be expensive although there are firms that offer template documents to help reduce the costs.
If creating employment opportunities for you or a family member are important to you, the family foundation is a better choice. This structure allows you to pay for professional services or hire staff to run the foundation. A family member can serve as staff if they are providing services required to operate the foundation and their compensation is reasonable. A DAF allows family members to recommend grants from the fund, but they cannot be compensated.
Donations into either type of account generally qualify as a charitable gift for income tax purposes. You can donate cash, stocks, bonds, mutual funds, real estate and other assets like closely held stock of a family business to either account type, but a DAF offers higher tax benefits over the family foundation. If you are looking for the maximum tax deduction, the DAF has the edge over a family foundation.
A few other IRS rules tilt in favor of the DAF over the family foundation. A family foundation is subject to a 2% annual excise tax on net investment income, must distribute at least 5% of the assets annually and is required to file a disclosure document annually. These rules don’t currently apply to a DAF which leaves more money for charitable giving, flexibility in grantmaking and privacy you don’t get with a family foundation.
It pays to shop around and ask questions of potential DAF sponsors to find one that is a good fit for you. Fees have started to decline, and some sponsors offer social impact investment options along with flexibility to work with your own investment advisor. Don’t forget about your local community foundations as an option. They’re often a good choice because they know your community and the local charities.
In my experience, DAF’s are an inexpensive alternative to a family foundation, and they fit virtually all philanthropists, no matter the size of the fund. Because of their more complicated nature and higher costs, advisors generally suggest $5 million dollars as the minimum level to start a family foundation. Some families with existing foundations are choosing to convert them into a DAF to reduce their expense and administrative burden.
They’re both excellent tools for philanthropy and will accomplish many of the same goals. Which one is right for you; a DAF or family foundation? Well, it depends!
Michael Howard is a Chartered Advisor in Philanthropy and the Chief Executive Officer of YouthBridge Community Foundation