Foundation basics

What are the differences between private foundations and donor-advised funds?

Private foundations and donor-advised funds are the two most common philanthropic vehicles in use today. They each have unique advantages and disadvantages, but what are the most important differences between them from a wide-angle lens? Essentially it boils down to this – private foundations are better suited for creating a team of people to engage in philanthropy while donor-advised funds are better suited for more individual giving.

What is the case for private foundations?

Private Foundations make a lot of sense when the donor wishes to collaborate with others to make grantmaking more impactful. With a foundation, the team can be made up of only close family members or it can be quite expansive with hired staff and a developed organization. The size and sophistication of the largest foundations is quite astonishing. For example, the Gates Foundation has more than 1,000 employees and makes use of professional operational techniques and state of the art technology. The Gates Foundation staff not only expend a great deal of time and resources vetting potential grants on the front end, but they also carefully track the outcome of the grants through careful record keeping and analysis. Of course, most foundations operate on a much more modest scale and the majority of foundations are small with the philanthropic team consisting of the original contributor and his or her close family members. 

What is the case for donor-advised funds?

Donor-advised funds are better suited for charitable donors who are looking to operate in a more solitary manner. Donor-advised funds typically have just one person or a married couple who are authorized to request grants. While it is usually possible to give more people authorization to request grants (oftentimes the donor’s adult children), each individual typically has equal power and can act independently of the group at large. For donor-advised funds it is not possible to hire staff or to incur any operating expenses such as performing due diligence on a potential grantee. With donor-advised funds, the deliberation that goes into grantmaking is on average less than with private foundations. Giving with donor-advised funds is often analogous to a simple check writing exercise. Donor-advised funds shine with their simple set-up procedures, low-cost ongoing administration, and more lenient rules for deducting contributions for tax purposes.

Can you convert a donor-advised fund to a private foundation or vice versa?

Donor-advised funds cannot be converted into private foundations. Donor-advised funds cannot provide funding to private foundations because they can only make grants to public charities. 

Private foundations, however, can provide grants to donor-advised funds. It is possible for a private foundation to completely liquidate its endowment by providing a grant to a donor-advised fund.

Features of Private Foundations

  • It is possible to build a substantive organization with a private foundation.
  • Private foundations allow deep family involvement for both the present and future generations. 
  • Private foundations normally have larger endowments and receive larger gifts.
  • Private foundations can receive additional contributions at any time allowing for additional tax deductions.
  • Private foundations provide great grantmaking flexibility with several options available over and above grants to officially recognized public charities (prize programs, individual assistance, grants to international charities).
  • Private foundations allow extensive control over the how the endowment is invested. For example, investments can be made in public securities, private equity, hedge funds as well as privately held businesses. 
  • Private foundations have an annual distribution requirement that is approximately 5% of their asset base.
  • There is an annual tax return that must be filed each year with a 1.39% tax on investment income.
  • Private foundations must pay their own administrative and operating expenses, which can be high depending on the foundation.
  • The charitable income tax deduction for private foundations is more restrictive than donations to public charities. Contributions of cash are deductible up to 30% of AGI while contributions of appreciated securities are limited to 20% of AGI. A five year carry forward of any remaining deduction is available.

Features of Donor-Advised Funds (DAFs)

  • DAFs are well suited to serve as a simple low-cost conduit for charitable giving. It is not possible to build a substantive organization around a DAF.
  • DAFs are easy to create and oftentimes accept a lesser initial contribution sometimes for as little as $1,000.
  • DAFs can receive additional contributions at any time allowing for additional tax deductions.
  • The donor retains the right to make recommendations to the sponsoring organization regarding onward donations to public charities. The recommendations are non-binding but in practice the sponsoring organization always follows these requests—exceptions are very rare.
  • The ongoing expense of maintaining a DAF can be quite low but the specific costs depend on the sponsoring organization. In general costs are low but some sponsoring organizations can have high fees.
  • The charitable income tax deductions for contributions to DAFs fall under the more lenient rules for contributions to public charities. Contributions of cash can be deducted up to 50% AGI while contributions of appreciated stock is limited to 30% of AGI. A five year carry forward of any remaining deduction is available.

Which Vehicle is Right for You?

Private foundations and donor-advised funds both have a place in the world of philanthropy. They offer distinct features and benefits. The right choice for you depends on your specific circumstances as they are both great charitable vehicles.  

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Foundation basics