The bad news about commercial donor-advised funds is getting worse.

As my loyal readers know, I’ve been giving attention here and in national journals to the negative impact that the burgeoning popularity of donor-advised funds is having on traditional charitable giving. People have been dumping money into Fidelity Charitable and Schwab Charitable in record numbers, to the point where in 2011 they ranked as the number two and number twelve “philanthropies” respectively in terms of money received from donors. Their cousin, Vanguard Charitable, hasn’t been doing so badly either, ranking number 22 on the Philanthropy 400. (To put their success in perspective, numbers 20 and 21 on the list were the not inconsiderable fundraising machines of Harvard and Yale.)

Now comes word that Schwab raised three times as much in the last half of 2012 as in the comparable period the year before. Fidelity’s numbers – supposedly revealing a similar growth – are due out this week. This is a phenomenal level of growth.

So what’s the problem with these numbers? Isn’t all charitable giving good?

Well, not really. These aren’t really charities, other than for their IRS classification. These are, in my coinage, NINOs – Nonprofits In Name Only.

Because they are technically 501-c-3 public charities, these commercial donor-advised funds provide the same charitable tax deduction as soup kitchens and homeless shelters and schools. But instead of actually providing charitable good, the donated funds here are going into holding tanks, to be invested in (and make money for) their corporate sponsors. Though the presumption is that the funds will be granted to charity over time, in fact there is no requirement whatsoever that the funds ever go out for actual charitable purposes. And with commercial donor-advised funds booming, and with overall charitable giving flat, this means that less is going directly to organizations that need the funding now.

Let’s give a real-life example to show why this is a problem.

I ran into a friend of mine on a plane not long ago. He’s a financial advisor for a respected mainstream brokerage firm. He described a client of his who had dropped $100,000 into the company’s donor-advised fund. (Note that, while Fidelity, Schwab and Vanguard are the largest and most famous of the commercial donor-advised funds, dozens more proliferate. My friend’s firm, for example, has its own donor-advised fund.)

This client received a $100,000 charitable deduction when he created the donor-advised fund. But in the five years since creating that fund, he has designated only a single $1,000 grant to an actual operating charity. So back in 2008 his $100,000 charitable deduction saved him some $28,000 in taxes (and cost the U.S. government that same amount), supposing he was in the 28% bracket. But only $1,000 has gone toward actual charitable purposes since that time.

And my friend, the broker? He’s been receiving commissions for the last five years for his client’s “funds under management” that have been in the company’s donor-advised fund. Let’s say that my friend gets a half-a-percent fee on those funds. (I’m guessing at the amount, which tends to be tiered based on the size of the total relationship, but I think this is in the range.) That means my friend has earned about $2,500 ($500 a year for five years) in brokerage fees for his client to have left the funds in place, rather than distributing them to charity.

And my friend’s company? I’m guessing that between fees on the donor-advised fund itself and the fees on the investments in the underlying mutual funds, the firm and its charitable gift fund arm are getting some 1.5% a year, or $7,500 over the course of the last five years.

So to sum up, by making this $100,000 “charitable” gift the client received $28,000 in lower taxes; my friend the broker received $2,500 in commissions; and my friend’s company received $7,500 in management fees. Meanwhile charities received…. $1,000.

I think there’s a fascinating and infuriating double-standard.  On one hand employees of nonprofits are prohibited by ethical standards from receiving a commission for funds they raise for the charities that employ them. On the other hand, for-profit financial advisors now regularly receive commissions for funds they help direct to “charities” – i.e. commercial donor-advised funds.

Meanwhile early reports are that overall charitable giving in 2013 will be flat. So as more and more money is rushing into these commercial donor-advised funds, less and less is going to organizations that provide actual services. Not only does this trend make a mockery of the charitable tax deduction, but it has terrible public policy implications, sucking donations away from important causes into this venal vortex of crass self-interest.

It’s clearer than ever that the government needs to impose some regulation and make sure these funds actually go out the door to good causes. Currently there is no federal requirement that any contributions at all be made from donor-advised funds.  I urge that Congress impose a 20% annual pay-out requirement so that these enterprises become short-term vehicles for getting money out to nonprofits. This preserves the convenience of donor-advised funds for the donors, but it would ensure that the funds would go out to the community within a few years’ time.

Or to put it another way: is it too much to ask that “charitable giving” involve just a little bit of charity?

By the way: I’ve started the process of getting in touch with my Congresswoman and Senators about this issue. Will you join me?

Copyright Alan Cantor 2013. All rights reserved.

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