Private foundations vs. donor advised funds

If you’re thinking about turning your yearly charitable donations into a legacy, the first question you might consider is “how.” Two of the more common ways to create a charitable legacy are donor-advised funds and private foundations.

The right choice for you likely depends on what you’re hoping to achieve. Dan Harris, national director of philanthropic services at U.S. Bank, says he always starts by asking clients what their goals are. If the client doesn’t have a clear goal in mind, he says looking at past donations is a good place to start. “They might ask themselves why they’re supporting specific organizations and not supporting others. They recognize that some gifts might be more meaningful.”

Having a goal in mind can make a big difference as you determine whether a donor-advised fund or private foundation is better equipped to help you achieve it.

What is a donor-advised fund?

With donor-advised funds, you create a fund in partnership with an existing charity, and then advise on the donations. Donor-advised funds have been the fastest growing type of charitable vehicle for more than a decade.

The first step in creating a donor-advised fund is to find a sponsor organization with which to partner. This must be a 501(c)(3) organization, which could be a community foundation, a university, or even a national charity created specifically to support donor-advised funds. Often, the sponsoring organization sets the rules for how money is donated. While donors can influence and advise on charitable investments, you won’t have the ultimate say.

“Some types of giving don’t work well with donor-advised funds,” Harris says. “For instance, if you want to create a scholarship program and you want complete control to decide on scholarship recipients.” Donor-advised funds don’t allow donors such control.

On the other hand, you don’t need to file tax forms every year. The sponsoring charity’s tax paperwork will cover your donation and generally doesn’t provide details how your money is spent. If you want to keep your giving private, this can be a positive. Additionally, the paperwork required to start a donor-advised fund is less time consuming (and less expensive) than for a private foundation.

Having a goal in mind can make a big difference as you determine whether a donor-advised fund or private foundation is better equipped to help you achieve it.

What is a private foundation?

Private foundations are independent legal entities that allow donors more control but require more work (and money) to create. Generally, the donor sits down with an attorney to describe the organization’s goal. From there, the attorney drafts documents and files them with the IRS. Next, the donor funds the foundation. Lastly, the foundation begins investing and making grants.

Private foundations can also partner with donor-advised funds, so it’s not always an either/or type of situation.

Weighing your choice

When people come to Harris with their intentions, he likes to start by exploring their giving style as well as their philanthropic objectives. Some families’ objectives may be very well served through a donor advised fund, while for others, a private foundation may be a much better strategy.

Donor-advised funds are simple and very easy to set up. They have relatively few rules, are inexpensive, and allow most donors to accomplish their goals. In contrast, private foundations take more time and expense to create, and they come with a variety of requirements such as creating a formal board of directors, holding meetings, tracking investments, making grants, and filing an annual tax return.

But the formality of a private foundation may be very attractive for some families, Harris says. The formality of a defined board of directors, with required meetings, decisions, and reporting, may help a family to accomplish other goals. A family foundation may help to pass on a tradition of charitable giving through the generations, to share philanthropic values, and to keep a family together even as the generations spread across the country or the globe. Family foundations are often established to exist in perpetuity, which can create a lasting legacy to honor the ideals of the donors.

In addition to what you hope to achieve, you may want to consider the tax implications. Both donor-advised funds and private foundations offer tax deductions, but the significance of these deductions varies. Harris points out that, generally speaking, these benefits are not the deciding factor for donors.