By: Alex Weiss CFP® | President & Wealth Manager

As we enter the new year, some of our clients are looking ahead at significant income events such as selling a business. Whatever the cause, the expected income comes with a hefty tax bill if no creative action is taken.

Two common charitable giving options often come up in these conversations: donor-advised funds and private foundations. Each has its own advantages and drawbacks, and the right choice depends on your financial goals, charitable intent, and the level of involvement you wish to have. 

Let’s explore the pros and cons of each option to help you make an informed decision.

Donor-Advised Funds (DAFs)

A donor-advised fund is a simple, flexible, and cost-effective way to manage charitable giving. Here are some of the key benefits and considerations:

Pros of Donor-Advised Funds

• Cost-Effective: For contributions of $1 million or less, DAFs are often the most practical choice. They have a lower cost structure compared to private foundations.
• Simplicity: Setting up and managing a donor-advised fund is straightforward. The sponsoring organization handles administrative tasks, including compliance and record-keeping.
• Flexibility: You can contribute to the fund, receive an immediate tax deduction, and decide later which charities to support. This is particularly helpful when you want to spread donations over time.
• Privacy: Donations through a DAF can be made anonymously, offering an added layer of confidentiality.

Cons of Donor-Advised Funds

• Limited Control: While you can recommend how the funds are distributed, the sponsoring organization retains final authority over grants.
• Investment Options: Choices for managing the fund’s investments are often limited to pre-selected portfolios provided by the sponsoring organization.

Private Foundations

A private foundation is a more personalized and permanent vehicle for charitable giving, typically suited for those looking to contribute $5 million or more. Here are the benefits and challenges of this approach:

Pros of Private Foundations

• • Complete Control: As the foundation’s founder, you determine its mission, charitable priorities, and grant-making process.
  • Legacy Building: A private foundation can become a multigenerational tool for teaching philanthropy and creating a lasting family legacy.
  • Broad Investment Options: Foundations can manage their own investments, allowing for a customized strategy.
  • Direct Impact: You can support niche causes or smaller organizations that align closely with your values.

Cons of Private Foundations

• Higher Costs: Establishing and maintaining a foundation involves significant fixed costs, including legal, administrative, and compliance expenses.
• Complexity: Foundations require ongoing management, including filing tax returns, adhering to strict regulatory requirements, and managing operations.
• Public Disclosure: Unlike DAFs, private foundations are subject to public disclosure requirements, meaning details about grants and financials are accessible to the public.

Choosing the Right Option

The decision between a donor-advised fund and a private foundation often hinges on several factors:

• Size of Contribution: For gifts under $1 million, DAFs usually offer the best balance of cost and flexibility. Between $1 million and $5 million, the decision becomes more nuanced and depends on your goals. For contributions over $5 million, the benefits of a private foundation often outweigh the costs.
• Purpose: Consider what you hope to achieve. Is the goal to create a lasting legacy, teach future generations about philanthropy, or maximize tax efficiency?
• Trust in Institutions: Confidence in the organizations you wish to support is critical. If you’re unsure about the long-term direction of an institution, you may prefer the control a private foundation provides.

Both donor-advised funds and private foundations are excellent tools for charitable giving, but they serve different needs. Donor-advised funds are ideal for those seeking simplicity, flexibility, and lower costs. Private foundations are better suited for individuals or families looking for control, a lasting legacy, and the ability to address unique or niche causes.

When deciding, it’s essential to consider your financial situation, charitable goals, and the level of involvement you desire. By aligning these factors, you can ensure that your philanthropic efforts make a meaningful and lasting impact.