Morningstar Column: How to Use Donor-Advised Funds to Support Sustainable Investment Goals
By Phuong Luong
This column originally appeared on Morningstar.com on July 19, 2023.
This article is part of a series providing a framework for incorporating sustainable investing into your advisory practice.
In my previous column, I outlined strategies for creating and implementing a giving plan. Several of my clients utilize donor-advised funds, or DAFs, to implement such plans. For clients with multiyear giving plans, it’s possible to apply sustainable-investing principles to assets within their DAFs. Depending on the goals in question, these funds can be useful for advisors to support both clients’ giving and their sustainable-investment goals.
Ways to Utilize a DAF
DAFs are managed and made available by sponsors. A DAF sponsor typically also serves as its administrator, managing account maintenance, grant processing, and record-keeping to ensure IRS rules and regulations are followed. DAFs may typically only grant to 501(c)(3) organizations for charitable purposes.
A donor chooses a sponsor, opens their DAF, and transfers stock or cash to the account. My clients are listed as donor advisors on their DAFs and can recommend grants from them. Other donor advisors may be listed on the DAF if the client would like to share grant decision-making responsibilities. After a donor advisor makes a grant recommendation, the DAF sponsor and/or administrator will review the grant, approve it if it’s an allowable transfer, and send a check to the receiving organization.
There are a number of reasons a client might be interested in using a specialized charitable investment vehicle such as a DAF to accomplish their giving goals. The structure of a DAF may ease the administrative work for donors and grant recipients. Instead of processing and monitoring transfers directly to multiple organizations, one irrevocable transfer of assets into a DAF can then be disbursed to multiple recipients as checks, which are often simpler for recipients to accept than noncash donations. In addition, not all receiving organizations may be able to accept noncash donations, such as publicly traded securities. In those situations, the donor may transfer a variety of noncash assets into a DAF that can then be sent to the receiving organization as a check.
Another benefit of DAFs is that the donor does not need to request or track down donation acknowledgment letters from each receiving organization to retain for their tax records. The donor instead receives one letter from the DAF administrator that combines all transfers made into the DAF in a single tax year to report as a tax-deductible donation on their tax return. Donors may also batch tax-deductible donations into a single tax year if the donor advisor knows the amount they’d like to donate over multiple years but has not yet determined the recipients.
Although some DAF sponsors have policies requiring minimum annual giving, they are not required to have minimum distribution requirements or time limits for assets held in the accounts. Most of my clients use DAFs as pass-through short-term intermediary accounts. Funds they transfer into the DAF are typically sent to organizations within that same year. In these situations, we keep assets in the DAF as cash and cash equivalents.
For various reasons, some of my clients are not ready or able to gift the total amount of their DAF within the year of their gift. For example, one might not know where they’d like to make the donations. I encourage such clients to work with a philanthropic advisor to create a giving plan and timeline aligned with their values that deploys and commits monetary resources to recipients sooner rather than later.
Some donor advisors may not have the authority to decide how much and how quickly they can give from the DAF. This can be the case when the client is not the sole donor advisor listed and grant recommendations are decided in collaboration with other family members. Some family members who hold donor-advisor roles on the same DAF may decide to maintain assets for long-term giving goals as one way to maintain relationships with each other. They may also want to maintain relationships with the communities and organizations they support, especially if the organizations have requested multiyear gifts as a steady stream of revenue or as a way to manage cash flow that they may not be ready to accept in the current year. In these situations, clients may value working with a philanthropic advisor to explore how to foster important personal and community relationships outside of philanthropic contexts, while they and their financial advisor explore investment options that align with their values within their DAFs.
Types of DAF Sponsors
Before I opened a client’s DAF for the first time, I compiled a list of sponsors to evaluate. I began by asking the client and other advisors for sponsors they’d heard of or had experience with, along with doing an online search. I could not find a full list or database of DAF sponsors. The National Center for Family Philanthropy estimates that there are over 1,000 such sponsors in the United States and offers a short list of sponsors and their unique offerings. There are a number of ways to categorize DAF sponsors. From my research, I’ve found five main types:
Community foundations are public charities established to benefit their local communities, and some sponsor DAFs. Examples include North Star Fund, The Boston Foundation, and The Foundation for Louisiana. The Council on Foundations offers a searchable database of such organizations.
Public foundations are public charities that support specific issues, typically by contributing assets to the organizations working within those areas, and some sponsor DAFs. Examples include Common Counsel Foundation and Bread & Roses Community Fund.
Nonprofit organizations may sponsor DAFs as part of their missions. Examples include Possibility Labs, Impact Charitable, RSF Social Finance, and Impact Assets.
Financial firms may sponsor DAFs as part of their suite of services. One example is Amalgamated Foundation.
There are independent sponsors that specialize in offering DAF administration and are not affiliated with a financial-services firm. Examples include the American Endowment Foundation and the National Philanthropic Trust.
Even DAF sponsors within the same type may vary on several key factors, such as minimum account size, how administration fees are calculated, minimum grant size, policies regarding where grants can be sent, and the types of assets accepted as transfers into their DAFs. For instance, almost all sponsors will accept transfers in the form of cash and publicly traded securities, but some will accept privately held assets such as real estate, restricted stock, or a business. Some DAF sponsors offer additional services, such as complimentary philanthropic consulting, to donor advisors.
Sponsors may also vary in how connected and aligned they are with the needs of communities. Some may have grantmaking committees directly led by community leaders and social justice organizations. Another key differentiating factor is how much discretion the donor advisor has regarding investment choices. Sponsors vary regarding the type of investments they allow and the services they provide, so it is important to find the right administrator for your client’s goals.
Sustainable Investing Within a DAF
If a client’s time frame for implementing their giving goals is one year or longer, DAFs may provide an opportunity for both granting and sustainable investing. I’ve written in previous articles in this series that sustainable investing is a spectrum. Clients may want to go beyond divesting from harmful extractive industries by making zero- to low-interest impact loans to Community Development Financial Institutions, community loan funds, and/or debt or equity impact investments in affordable housing, small businesses, and social enterprises. Most sponsors allow advisors to hold publicly traded investments within their DAFs, and some DAFs allow private investments. There are also investment vehicles that incorporate the features of a donation, such as recoverable grants where the principal may be returned to the DAF.
In addition, some sponsors have their own in-house investment managers and maintain portfolios in which all their DAF accounts are invested, potentially with some customization of investments permitted. RSF Social Finance maintains a standard portfolio of private impact investments earning a fixed interest rate. Amalgamated Foundation offers a menu of sustainable publicly traded investment options, ranging from fossil-fuel-free possibilities to supporting community investment. Impact Assets offers a menu of impact investment portfolios that are customizable with private debt and equity fund offerings.
Some sponsors permit a donor advisor to assign an investment manager for support with a DAF account. The sponsor may offer portfolio options for the donor advisor and their investment manager to choose from and/or allow them to create a custom portfolio. Common Counsel allows a donor advisor and their investment manager to manage their DAF at a custodian of their choice and permits holding nonpublicly traded investments if they can maintain such a portfolio.
Where to Learn More
The Initiative to Accelerate Charitable Giving is a coalition of philanthropists, foundations, public charities, nonprofit organizations, and other community leaders promoting more accountable charitable giving. One major criticism of DAFs is that they may keep assets indefinitely. According to the Initiative, “DAFs now have over $140 billion set aside for future charitable gifts. The problem is that current rules fail to provide any incentives or requirements for DAFs to ever distribute their money.” The initiative supports reforms to significantly increase the timely flow of resources from charitable intermediaries to communities.
There are a growing number of DAF sponsors that require donor advisors to spend down assets rather than hold them in perpetuity. One example is Seeding Justice, based in Oregon, which refers to its DAFs as Donor-in-Movement Funds and requires a 100% payout within 12 months of account opening. Half the grants are made by a grassroots participatory grantmaking committee, and 40% of the grants go to mission-aligned organizations of the donor advisor’s choosing.
I encourage my clients to develop a giving plan to fully distribute from their DAFs within a defined time frame. When giving all the assets immediately isn’t feasible, it’s still possible to align assets earmarked for giving with a client’s values. There are a number of organizations that provide resources for using charitable assets for sustainable investing. ImpactPHL’s Total Impact Summit is an annual conference focused on impact investing and leveraging tools such as DAFs across geographies and issue areas. CapShift and Social Finance work with DAF sponsors, as well as individual and institutional investors and grantors, to offer and administer recoverable grants and other impact investments. As an advisor, you can help your clients choose a DAF sponsor that can carry out their giving goals and collaborate when needed to facilitate sustainable investments.