Private foundation, donor-advised fund or both: Here are tips for deciding what makes sense for your charitable dollars

At some point, individuals who are charitably inclined might determine that writing checks here and there to various nonprofits is no longer cutting it.

For those who want a more permanent way to help the greater good during their lifetime, and perhaps beyond, options include either a private foundation or a donor-advised fund. While they are similar, there are some differences that can help you figure out whether either (or maybe both) is right for you.

“They are both devices that let you donate money now and give it out over time,” said certified financial planner Mitchell Kraus, cofounder of Capital Intelligence Associates in Santa Monica, California.

“The biggest difference is that a donor-advised fund is more a simplistic solution … but doesn’t allow for as much flexibility,” Kraus said.

Here are some tips for helping you decide.

Generally speaking, these are easy to set up and maintain: You fund your account and get a tax deduction, and then can decide over time when and how much to grant to charitable causes.

These funds are sponsored by either a community foundation or other group (i.e., a hospital or church), or a national nonprofit that may be affiliated with a financial company like Fidelity Investments or Vanguard. Some funds may be more restrictive about where your grants go.

“Say it’s sponsored by a religious organization — it may have charities it won’t grant to,” said CFP Howard Hook, principal and senior wealth advisor for EKS Associates in Princeton, New Jersey.

“Just be sure ahead of time that it will accept the grants you recommend,” Hook said.

You can get a tax deduction for contributed amounts worth up to 60% of your adjusted gross income, or AGI, to a donor-advised fund. For appreciated assets, the deduction cap is 30%. If you exceed those donation limits, you can carry over excess deductions for up to five more years.

It’s also worth knowing that a temporary rule (for 2020 and 2021) allowing charitable cash contributions worth up to 100% of your AGI does not extend to money you put in a donor-advised fund, Hook said.

These funds may or may not have a minimum amount you need to set one up, though they all generally will have an annual cost to you. For example, at Fidelity — one of the largest sponsors of these funds — there is no minimum, and the cost is roughly 1% of your balance annually. That includes administrative costs and investment fees, and is deducted from your account.

You also can donate assets that you’ve held for more than a year — say, stock or real estate — to the donor-advised fund and, generally speaking, get a tax deduction for the asset’s value.

“When you donate highly appreciated property, you essentially avoid paying capital gains tax you would have had if you sold the asset,” said David Mendels, a CFP and director of planning at Creative Financial Concepts in New York.

Additionally, if you want to, you can make anonymous donations from your account. And, there currently is no timeline for distributing the money you contribute. (This aspect of donor-advised funds is under fire from critics who contend that individuals are making contributions and getting the tax deduction but are not necessarily giving out grants in a timely fashion.)

Generally speaking, setting up a private foundation involves more legwork and cost. This may make it less appealing to individuals with more limited resources.

For instance, you could spend anywhere from $4,500 for a service that specializes in foundation administration to upwards of $25,000 for private attorneys that handle the process, according to the American Endowment Foundation.

“I generally don’t get serious about having a conversation with a client about a foundation until they have about $2 million or $3 million to donate,” said Kraus at Capital Intelligence Associates. “You could end up spending more on accountants and attorneys than the causes you care about.”

In addition to ongoing administrative costs, there are tax-filing requirements that don’t come with donor-advised funds. And, generally, 5% of assets must be distributed annually and there can be an excise tax of 1.39% on net investment income.

The tax deduction for contributions to your foundation are lower than with donor-advised funds: limited to 30% of AGI for cash and 20% for publicly traded securities. (Although you can carry over excess amounts for up to five years.)

Nevertheless, “some people feel very strongly about being able to manage a foundation,” said Hook at EKS Associates.

Part of that is the flexibility that private foundations offer in terms of which causes you want to support. 

“You have more control because you can basically give to whomever you want,” Hook said.

You also get to choose who you want to sit on your board of directors and make decisions about charitable endeavors.

Depending on the type of foundation, you can donate to existing public charities, make international grants, award scholarships or even give funds directly to individuals for disaster relief and hardship assistance, according to Foundation Source. Some private foundations also create their own programs to operate, although most do not.

“For someone who wants complete control, or has been an entrepreneur and likes building something from the ground up, a private foundation can be appealing,” Kraus said. 

Some people may decide that setting up both a foundation and a donor-advised fund makes sense for them. One reason is privacy.

“Sometimes a person wants the publicity of a donation from their foundation, but they may also support a cause they don’t necessarily want known publicly,” Kraus said. “And that can be done on an anonymous basis with a donor-advised fund.”

For instance, he said, a person might support a cause that’s controversial — i.e., on one side or the other of gun rights or abortion rights — and would rather keep that fact out of the public eye.