Big News — But Not Good News

[Note: This commentary is cross-posted in the November 15, 2012 edition of the  Chronicle of Philanthropy.]

Today it’s my duty to point out a disturbing trend for America’s charities.

Each year the Chronicle of Philanthropy compiles the Philanthropy 400, a list of the nonprofit organizations that have raised the most money in the past year. The troubling news? The number two nonprofit for 2011 was an entity called Fidelity Charitable.

Fidelity Charitable is not like most of the other nonprofits at the top of the list: United Way, Salvation Army, and CARE. Fidelity is what we might call a NINO – a Nonprofit In Name Only. It provides no services to the community, other than to gather and manage money in accounts that the donors can eventually distribute to charities of their choice.

That money can stay locked up in a Fidelity account indefinitely, because the federal government doesn’t set any rules for how much should be distributed annually from the donor-advised funds that comprise Fidelity Charitable. At a time when, according Giving USA, overall inflation-adjusted charitable giving is flat, that means a great deal of money is being diverted from human services organizations, schools, arts programs, and conservation groups, essentially to be warehoused for future use.

It’s time for nonprofits of all kinds to understand that Fidelity’s growth is coming at their expense – and to push for changes in the tax code that encourage people to give directly to nonprofits that are providing vital services and advocacy in their communities.

It would be worrisome enough if Fidelity were alone in taking such a big piece of the giving pie. But other commercial donor-advised funds are also growing far faster than virtually any other kind of nonprofit in America. In 2011, contributions to the three largest commercial gift funds rose 77%.

Donor-advised funds are gaining popularity because they are a too-good-to-be-true deal for the donors, who get a charitable deduction upfront and can then designate the money to individual charities at their leisure. The tax benefits – particularly for contributions of real estate, business holdings and other complex assets – are more generous than for private foundations. And the structure is far simpler than creating one’s own private foundation.

But commercial donor-advised funds are gaining rapidly for other reasons too. One is the financial incentive for the donors’ brokers. Though commissions in the financial sector can be opaque, the truth is that financial advisors frequently draw fees when they persuade clients to create a donor-advised fund. That’s obviously not the case when a donor makes an outright gift to an operating charity. And because the adviser often continues to draw fees based on the balance in the donor-advised fund, he or she has little incentive to encourage donors to give money away at a rapid clip.

Other reasons for the tremendous growth in commercial donor-advised funds: their marketing savvy and technological sophistication. Clients of financial institutions see marketing messages for advised funds when they go online to make their regular business transactions. And because the commercial gift funds make it so easy to disburse grants – one click and the check is on its way – it’s easy to understand why donors are so easily seduced.

The whole idea that a company would offer donor-advised funds is relatively new. For several decades, the primary organizations that housed donor-advised funds were community foundations and religious denominations. Then in 1992 Fidelity Investments established the Fidelity Charitable Gift Fund.

Now known as Fidelity Charitable, the organization is considered a 501-c-3 public charity under the Internal Revenue Code, a status that many of us in the nonprofit world questioned from the start. It has a board of directors distinct from Fidelity Investments, though all of the money is invested in Fidelity mutual funds (and thus earns Fidelity Investments fee income).

Dozens of other for-profit corporations soon followed Fidelity’s example and got into the donor-advised fund business. Today the three largest are Fidelity, Schwab and Vanguard, which rank second, twelfth, and twenty-second, respectively, on the Philanthropy 400. To put this in perspective, Harvard University ranks twentieth, and Yale is twenty-first.

By 2011, gifts to donor-advised funds had grown to the point where, according to figures from Giving USA and the National Philanthropic Trust, they captured 4.4% of all charitable giving from individuals, and the trend is pointing upward. The commercial gift funds are becoming increasingly aggressive in soliciting contributions: for example, Fidelity is now pitching directly to estate planners about their ability to accept assets such as real estate and closely-held stock. Will donor-advised funds soon account for ten percent of annual charitable giving? Twenty percent?

Defenders of donor-advised funds say they are a boon for charitable giving and nonprofits. They claim that donor-advised funds promote philanthropy by making it easy. They point out that, on average, donor-advised funds distribute a higher percentage of their assets annually than do private foundations. But the fact is that more money is going into donor-advised funds than is going out. They’re a net drain to the sector.

Above all, I find it disturbing that federal tax policy doesn’t require the funds to distribute even a single penny in a given year.

I’m a relatively lonely voice in publicly criticizing donor-advised funds, but I’m in a chorus of millions singing for an overhaul of the tax system. If and when that happens, Congress should tighten the rules for charitable deductions to encourage gifts that provide immediate benefit to society. Perhaps the full deduction should be offered only for donations to groups providing direct services, while people who give to donor-advised funds or their own foundations would receive only a partial deduction.  In addition, lawmakers could demand that each fund be required to distribute a significant sum each year, or perhaps spend all their money over a specific time period. For example, Boston College Law School professor Ray D. Madoff, a critic of donor-advised funds, advocates a seven-year window for spending down funds.

These ideas will no doubt agitate many people in philanthropy, particularly those at the commercial gift funds. But if revised public policies produce additional badly-needed money to relieve hunger, homelessness, illiteracy, poverty, and environmental disaster, then this is a fight worth having.

Copyright Alan Cantor 2012. All rights reserved.