The 4 biggest knocks against donor-advised funds — and why I call them myths

When I mention donor-advised funds to friends and colleagues outside the wealth management industry, I am often met with either a blank stare or an, "Oh yeah, I think I know what those are." 

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In fact, DAFs act as charitable investment accounts, allowing clients to make contributions to a dedicated fund and then distribute money either immediately or at any time in the future. Investors get the immediate tax benefit based on the value of the assets at the time of donation. Since DAFs allow donors to streamline their giving, invest their charitable funds for tax-free growth and ultimately maximize the impact of their generosity, it makes sense that the number of DAF accounts has grown significantly, with 2021 seeing a 27.6% growth over 2020.

But with that popularity has come a certain level of controversy and criticism. That is why in my firm, which offers a bird's-eye view of various DAFs and how they can aid in meeting charitable giving goals, I often come across individuals who are active in philanthropy but who have made a conscious decision to eschew DAFs as a vehicle for their charitable giving. 

Here, then, are the top four criticisms of DAFs — and why I call them myths.

Hoarding of funds
Funds can be held in the DAF account indefinitely and may not be distributed to charities for a long time. That gives rise to one of the most prevalent critiques of DAFs: that they facilitate the hoarding of funds and act, in effect, as asset warehouses, keeping these funds in a sort of limbo, never achieving their purpose of making a difference. Some critics even argue the government should impose new regulations on DAFs to accelerate the payout rate to charities.

But a new study from the DAF Research Collaborative concludes that DAFs effectively regulate themselves.The vast majority of sponsors, at least 83%, it found, have written policies about regulating inactive accounts. It also found that DAF sponsoring organizations intervene after an average of 36 months with no grantmaking. The study also found that after trying to reactivate the fund, sponsors allow an average of 18 months for donors to respond before closing the account or assuming the grantmaking.

The potential for self-dealing
Critics express concerns that DAFs can be used for self-dealing, wherein donors recommend grants to organizations with which they have personal or financial connections. And this is correct: Donors' influence over distributions is a core principle of DAFs as it empowers donors to support causes they are passionate about. 

However, DAFs operate under the oversight of sponsoring organizations, which are legally obligated to ensure compliance with regulations and charitable purposes. Donors may recommend grants but the sponsoring organization has the final authority to approve or deny those recommendations. 

Further, DAF sponsors have processes in place, such as annual disclosures and recusals during decision-making, to prevent conflicts of interest while assessing grant recommendations. This system balances donor intent with responsible stewardship and ensures that all grant recommendations are made based on the charitable purpose of the fund rather than personal or financial gain. DAFs are also subject to strict regulations and oversight from the IRS, further ensuring transparency and accountability in the granting process. 

DAFs are only for the ultrawealthy
Philanthropy may bring to mind images of outsized checks with lots of zeros at the end. This is why people often associate donating to charity with well-publicized grand gestures of wealth and generosity, leading to the misconception that DAFs are reserved only for the ultrawealthy. 

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The reality is that donor-advised funds are accessible to anyone looking to support causes they believe in, no matter their level of wealth. With DAFs, it's not about how large your initial donation is but rather your lasting commitment to supporting the organizations and causes that matter to you. A study from the DAF Research Collaborative found that DAFs support the full range of individual donors and charitable giving strategies. According to the organization, while 11% of DAFs had over $1 million in assets, 45% of DAFs had assets between $50,000 and $1 million and 44% of DAFs had assets under $50,000. The study pointed out that donor-advised funds can be opened with amounts as low as zero dollars.

DAFs are tax loopholes disguised as philanthropy
Many argue that donor-advised funds' main appeal is that they allow donors to take advantage of tax loopholes or avoid paying taxes on certain donations without, as mentioned above, immediately deploying funds to charitable projects. But I would argue that DAFs allow donors more control and intention over their giving by allowing them the time to research and plan their philanthropic giving effectively. This long-term approach often leads to more thoughtful and strategic giving decisions, resulting in a more significant impact over time. 

Moreover, the option for long-term giving allows donors to respond to changing needs and emergencies effectively. According to November 2021 research from the Women's Philanthropy Institute, partnered couples gave less to charity compared with before the pandemic. However, a recent analysis of DAF activity during the same time shows grants to charitable organizations increased 29.8% by dollar value, as donors with money already in donor advised-fund accounts were uniquely positioned to continue supporting the causes they cared about. 

Furthermore, since assets or funds contributed to a DAF account become property of the fund sponsor, donors do not have complete control over the assets or the ability to reclaim them for personal use. This ensures that the funds are ultimately used for charitable purposes and cannot be exploited for personal gain or tax evasion. Donors can save on capital gains taxes when donating an appreciated asset to their DAF, but this only allows for a greater overall impact on their philanthropy. 

To sum up, there is a reason why such a wide variety of national, regional, local, religious and issue-specific DAFs have proliferated over the past few years: They bring tremendous value, not just to donors, but also to charities. When donors are educated on DAFs and can choose the right one for them, they can make the greatest impact on the causes that matter most to them.  Of course, the first step is understanding the benefits of a DAF and why critiques of them often fall into the category of "myth."