When it comes to establishing an appropriate philanthropic vehicle, the two most often chosen are Private Foundations (PF) and Donor Advised Funds (DAF). Both have their distinct advantages, as well as some drawbacks. DAFs have become increasingly popular over the past few years, especially given the speed of setup and ease of operation. But for many, the limitations of a DAF make a private foundation the more obvious choice. Understanding the differences between the two is critical to deciding which is more appropriate for any given family or circumstance.
1. A private foundation is a true legal entity, whereas a DAF is best thought of as an account held with a sponsoring charity in the name of the donor. This is vitally important when it comes to the issue of control. Because a foundation is structured as an independent corporation (or trust), it is under the complete control of the founders/board of directors. Assets put into a foundation remain fully managed by the foundation leaders. By contrast, a DAF is a fund controlled by the sponsoring charity. Donors establishing a DAF retain advisory rights as to how the funds may ultimately be distributed to charity over time, but ultimate control rests with the DAF sponsor.
2. Private foundations offer a wider array of giving choices. Assets within your private foundation are permanently dedicated to a charitable purpose, of course, but the variety of potential giving beneficiaries is quite large. Possibilities include:
- Grants to 501(c)(3) public charities
- Grants to other foundations
- Grants to needy individuals
- Scholarship programs
What really sets a private foundation apart when it comes to distributions, though, is the freedom to stretch out beyond the bounds of traditional charity, including a program related investment, or PRI, into a for-profit company that support the foundation’s purpose. A DAF is much more limited in its distribution targets, with recipients usually limited to 501(c)(3) public charities.
3. A private foundation can be funded with many different types of assets. The most obvious assets that are contributed to a private foundation are cash and securities, but it doesn’t have to stop there. Land, buildings, art, and other tangible assets can be transferred into a foundation. Partial or complete interest in a business can also be donated, keeping business holding limitations in consideration. Donations to a DAF are typically limited to cash and securities. In some circumstances, the DAF sponsor may allow other assets to be donated, but they are usually sold immediately.
4. Private foundations can have employees. And, those employees may even be board members or family members. The rules are strict regarding insider dealing, but as long as the position is ordinary and necessary, and compensation reasonable, employment is possible. A DAF is only a fund, not an entity. As such, a DAF cannot have staff.
5. A private foundation doesn’t lock you down. Because a private foundation provides much more flexibility than a DAF, you retain much more control over outcomes. Not so much with a DAF. In the past year, we have had two new clients come to us, independently of each other, to establish private foundations, only for us to discover that both clients intended to fund their new foundations with money sitting in a DAF. Both had followed bad advice from accountants who recommended they park over a million dollars each into a DAF until such time as they were ready to start their foundation. Unfortunately, most DAFs have strict rules prohibiting distributions to private foundations. And though the IRS may allow it, it often results in significant tax penalties. For both clients, their DAFs prohibited it. You can imagine that both clients were devastated to learn what that bad advice would ultimately cost them. By contrast, money donated to a private foundation could be used to establish a DAF at any time.
6. A private foundation provides the best base legacy-building. Though some DAF sponsors allow successor advisors, nothing beats a private foundation for creating a family legacy of philanthropy. Control can be maintained in a single family, allowing for successive generations to participate in giving. This is especially important for high net worth families who may be looking to fund a foundation with a large initial gift, from which to give out of for many, many years.
This is not an exhaustive list of the differences between the two. And though this article tends to favor private foundations over DAFs, there are times where a DAF makes more sense. This is especially true for people who may be contributing smaller amounts in establishing their philanthropic base, and for those for whom super-simplicity is most important. For everyone else, however, private foundations provide the level of control, flexibility, and legacy-building that can’t be matched with a DAF.
Foundation Group provides expert private foundation formation and ongoing compliance services. Learn how our professionals can make it easy for you to establish a legacy of giving!