Considering a Private Foundation or Donor-Advised Fund? You May Want Both.

June 15, 2023
Head of Philanthropic Advisory Kerri Mast discusses a common dilemma among philanthropically inclined individuals: the decision to set up a private foundation vs. a donor-advised fund.

Individuals interested in philanthropy often grapple with the question of whether to use a private foundation or donor-advised fund (DAF). In the past, the answer may have turned on size. Those making large gifts funded private foundations, while smaller gifts funded DAFs. Though size may remain a consideration – individuals can establish a DAF with $5,000 but would not set up a private foundation at that level – it is no longer a deciding factor for large charitable vehicles. So how does one decide?

There are advantages to each.

Private foundations allow individuals to retain control, pay charitable expenses (including salaries), and are often considered to be the most prestigious charitable vehicle, as they are used by many of the United States’ wealthiest families.1 DAFs, which have gained huge popularity in recent years, offer simplicity in administration, higher income tax deduction limitations, and no required payout rates.

But both have downsides, too.

Private foundations have to file a separate tax return, which includes the value of the foundation and the size and recipient of each grant. All of this is public information. In addition, their net investment income is subject to a 1.59% excise tax, while public charities do not pay tax on investment income. Private foundations are also required to distribute at least 5% each year in support of their charitable purpose. In addition, the rules governing private foundations can be complex, creating traps for the unwary.

With DAFs, individuals relinquish control – at least legal control – and, while they can advise as to grants and investment allocation, that advice is not binding. In addition, DAFs do not allow individuals to pay expenses, such as salary or travel expenses. Further, certain DAF providers may restrict grantmaking or investment options. For example, a faith-based DAF provider may prohibit grants whose purposes are deemed antithetical to that faith, or a locally based DAF provider might restrict grants to a certain geographic area. Individuals may also have limited investment options. For example, many DAFs offer narrow investment choices from pools of their mutual funds. (However, it should be noted that certain DAF providers do allow donors to select their own investment manager.)

After weighing the advantages and downsides and choosing one, what if a person feels he or she has made the wrong choice? If individuals start with a private foundation and have buyer’s regret, they can transfer the assets into a DAF. But it does not work the other way around. Assets cannot be moved from a DAF into a private foundation.

For some, using both may be the best solution.

In lieu of selecting one vehicle or the other, some people elect to use both a private foundation and DAF. There are a number of reasons this may be appropriate, including managing the minimum payout requirement, managing excise tax exposure, avoiding mission drift, and shifting certain administrative responsibilities.

Managing the Minimum Payout Requirement. As mentioned, private foundations are required to distribute annually 5% of their value in support of their charitable purpose. There may be years when a private foundation is not prepared to make a distribution. This could be due to a shift in grantmaking strategy, a large infusion of assets, or an event that pulls the family’s attention away from the foundation for a period of time. A foundation’s distribution to a DAF counts toward its 5% distribution requirement. This allows the foundation to make its required distribution now but withhold a decision regarding the ultimate recipients.

Avoiding Mission Drift. Private foundation boards often establish mission statements and grantmaking guidelines. These can be helpful for creating a focused grantmaking program. Even when a foundation has a focused grantmaking program, board members often have individual philanthropic interests outside of the focus area. For example, consider a foundation that supports affordable housing initiatives. The board members, while committed to affordable housing, may also wish to support their respective alma maters, their houses of worship or other local interests. It usually is permissible for a foundation to make distributions in support of these initiatives. However, in an effort to avoid drifting from the stated mission, and from publishing off-mission grants on the publicly available tax return, many foundations use a DAF to make grants that are outside of their stated mission.

Shifting Administrative Responsibilities. As noted, DAFs can provide administrative simplicity. This can be useful in a variety of situations. Consider, for example, a grant to an international organization. If a private foundation makes a grant to an international organization, it is required to exercise a certain level of due diligence called expenditure responsibility. Expenditure responsibility requires enhanced record-keeping over a period of time. Private foundations can develop a process for exercising expenditure responsibility. Alternatively, as certain DAFs are structured to provide expenditure responsibility, the private foundation can make international grants through a DAF, thus relieving the foundation of this administrative burden. 

Example: John and Sallie Jones have significant charitable intent. They plan to join Warren Buffett, Mark Zuckerberg and Priscilla Chan, and others who have signed the Giving Pledge by leaving the majority of their wealth to charity. They have one daughter, Bonnie, who is finishing graduate school and has a developing interest in philanthropy.

John and Sallie intend to be closely engaged with their philanthropic endeavors, and they like the control afforded through a private foundation. They also like the idea that, in the future, Bonnie could work for the foundation and receive reasonable compensation. They are not concerned that the additional administrative requirements will be overly burdensome, as they have capable advisors to assist them. And they know if they get tired of the private foundation structure, they can move the assets into a DAF.

John and Sallie establish the Jones Foundation, a private foundation, and fund it with $100 million. The foundation’s primary purpose is to support environmental causes. They run an open grant cycle whereby environmental organizations can request a grant. The board of directors comprises John, Sallie, and Bonnie.

After three years, the Jones Foundation’s focused grantmaking process is running smoothly. In addition to environmental causes, each board member has personal philanthropic interests. John and Sallie want to support their respective alma maters and their house of worship, and Bonnie wants to support the local soup kitchen and animal welfare organization. While the Jones Foundation could support these organizations, the board wants to retain its sole focus on environmental causes. John and Sallie establish the Jones Family Fund, a DAF, and the board funds it with a distribution from the Jones Foundation. The DAF is used to support the philanthropic interests of individual board members that fall outside of the Jones Foundation’s mission.

After 20 years, the Jones Foundation hires Bonnie as its executive director. The board charges Bonnie with reviewing the foundation’s impact over the first two decades and refining its grantmaking strategy, as appropriate. To give Bonnie time to develop recommendations, the Jones Foundation would like to defer part of its grantmaking and transfers its required distribution to a DAF. This allows it to make its required distribution now but withhold a decision regarding the ultimate recipients.

After reviewing the grantmaking strategy, Bonnie recommends using a small portion of the Jones Foundation’s grantmaking budget toward strategic international grants relating to land conservation. In lieu of developing its own process for the exercise of expenditure responsibility, the foundation partners with a DAF that provides these administrative services. The Jones Foundation continues to make all of its domestic grants directly but uses its DAF to make grants requiring expenditure responsibility.

In this example, John and Sallie Jones met their primary philanthropic objectives through a private foundation. However, they found a DAF helpful when certain opportunities and challenges were presented.

When choosing a philanthropic vehicle, people likely will consider both a private foundation and a DAF. There are advantages to each, as well as a few limitations. Philanthropically inclined individuals may find it useful to use both and tailor the use to their particular circumstance. If you are interested in discussing your philanthropic vehicles further, please reach out to our Philanthropic Advisory team.

Contact Us

1 Three hundred of the top 400 wealthiest families in the United States use private foundations. Source: Silk, Roger D., and James W. Lintott, “Managing Foundations and Charitable Trusts.” 1st ed. Bloomberg Press, 2011.

Brown Brothers Harriman & Co. (“BBH”) may be used to reference the company as a whole and/or its various subsidiaries generally.  This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented.  This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. Pursuant to information regarding the provision of applicable services or products by BBH, please note the following: Brown Brothers Harriman Fund Administration Services (Ireland) Limited and Brown Brothers Harriman Trustee Services (Ireland) Limited are regulated by the Central Bank of Ireland, Brown Brothers Harriman Investor Services Limited is authorised and regulated by the Financial Conduct Authority, Brown Brothers Harriman (Luxembourg) S.C.A is regulated by the Commission de Surveillance du Secteur Financier. All trademarks and service marks included are the property of BBH or their respective owners. ©Brown Brothers Harriman & Co. 2023.  All rights reserved. PB-06169-2023-03-02

As of June 15, 2022 Internet Explorer 11 is not supported by BBH.com.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

 
1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com



captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction