DAF Myths: Demystifying Donor Advised Funds

Donor Advised Funds (“DAFs”) serve as a bridge between donors’ intentions and the realization of their charitable goals. DAFs often operate as charitable foundations offering services to groups of donors with a variety of goals. DAFs sometimes provide a wide variety of services including investment management and gift planning. And, there are over 20,000 donor advised fund accounts in Canada. So, as their growth continues, several myths about DAFs have become commonplace. This post will debunk some of those DAF myths.

DAF Basics

What is a DAF? Donor Advised Funds are typically registered public charities created to manage charitable donations on behalf of many donors including other charities, corporations, and individuals.

The number of foundations currently offering DAFs to Canadian donors is in the range of 230 – 240. However, its impossible to tell exactly how many DAFs exist since there’s no separate registration category for them with CRA. About one in five of the approximately 200 community foundations in Canada actively offer DAFs. Other DAFs include those offered by financial institutions and those offered on behalf of religious groups. About 55% of DAF assets are held by community foundations, 22% by financial institutions, 14% by independent institutions, and 9% by religious groups according to one study.

Part of the capital held at DAFs is endowed and invested to generate financial returns that will go towards supporting charities. Other capital held by DAFs is simply “flowing through”. On its way to other foundations or directly to charitable organizations.

Common donor advised fund myths

Next, this post will answer some of the most common questions that create donor advised fund myths:

• Do DAFs provide ongoing tax benefits to their donors?
• Can donors Withdraw money from their DAF?
• Do the tax benefits of DAFs outweigh the costs?
• Can donors accrue private benefits by using DAFs?
• Are DAFs available to all donors?
• Is capital is being hoarded in DAFs?
• Are DAFs expensive? Or are DAFs cheap?
• Are DAFs profit centers for financial institutions?

DAF Myths #1: DAFs provide ongoing tax benefits to their donors

When a donor makes a gift to a donor advised fund, they receive a charitable tax receipt for the value of their donation. Generally, this means Canadians are credited 15% of the first $200 of donations and 29% of additional donations above the first $200. Provincial donation tax credits on the first $200 and amounts above the first $200 range between 4% to 25%.

Using a charitable tax calculator from CanadaHelps (which is a national DAF) shows that a $1 million donation from an Ontario taxpayer results in $401,559.78 worth of tax credits. This means the donor gives up $598,440.22 after tax to make a million dollar donation to charity. So, if a donor wants to be better off financially, they should avoid making charitable donations. Because, no matter what your marginal tax rate, donors receive less in tax credits compared to the value of their donation.

Once a donation to a DAF is made, and the tax receipt is issued, there are no further tax benefits that accrue to donors. As the DAF invests the capital donated or gifts it to charities, the original donor won’t receive any further benefit (unless they keep giving).

DAF Myths #2: You can withdraw your money from a DAF

Once a charitable gift is made to a DAF, donors cannot take it back. So, let’s say a DAF donor chooses to invest their DAF account value into an investment portfolio. No matter how well the DAF portfolio may perform, the capital is the property of the DAF, and no longer owned by the donor. The funds inside a DAF cannot be used personally by the donor. It can only be directed to other registered charities and qualified donees.

DAF donors may choose which charities receive the proceeds of their DAF account. Or, in some cases how their DAF is invested. But, donors can never receive a refund of their donation. Plus, the only place where DAF capital can be sent is to qualified donoees. Not anyone’s personal account. Qualified donees include registered charities, registered charitable foundations, and most government entities. In other words, capital from a DAF cannot be sent to a family member or a friend.

DAFs, like all other registered charities also have minimum disbursement quotas. This means that they must give at least 3.5% but in most cases 5% of their capital to qualified donees each year.

DAF Myths #3: DAFs provide tax benefits (that outweigh the cost of donations)

When donations are made to DAFs, donors receive charitable tax receipts for the value of their donation. But, in all cases, this tax benefit only makes up a portion of the cost of the donation. Even in the highest marginal tax bracket, charitable donations may only provide a tax benefit worth less than half of the value of donations being made. Its also worth noting that charitable tax receipts are tax credits that can be used to offset taxes otherwise owed. So, for a donor to use the tax benefits from their charitable donations, they need to have enough income tax owing to offset. However, any charitable tax credits that cannot be used in the year of a donation can be carried forward with some restrictions.

DAF Myths #4: Donors can accrue private advantages by using DAFs

Canadian taxpayers should not receive private benefits from their charitable donations. It is against the law for donors to receive kick-backs or soft dollar benefits by the charitable donations they make. And, the receipted amount of a donation should reflect any advantage donors receive. However, there are some cases where some ancillary benefits may be derived from a donation, such as a ticket to an event. But this is where split receipting rules apply. A charity will simply modify the amount on the charitable receipt to adjust for any advantage received by donors. Such as the event cost.

When a donation is made to a DAF, the donor will be provided with a receipt for the value of their donation. Any other services that a DAF account holder may be provided with (such as charitable advisory services) is often paid for by fees from DAF account holders. Many DAFs charge fees for their services.

DAF Myths #5: DAFs are only available to wealthy donors

A common myth of donor advised funds is they are only available to wealthy donors. In fact, one of the best aspects of DAFs is they make charitable gift planning available to all donors. Some DAFs, such as the Charitable Impact Foundation, have low or no account minimums. This means that donors with small pools of capital can still use donor advised funds to create charitable savings accounts. And potentially share charitable donation and fundraising strategies with other DAF holders. Much like mutual fund investors receive benefits by pooling their investment capital.

Some DAFs that provide specialized services charge fees. Such DAFs include MakeWay Foundation which provides impact investing services. Or, Benefaction Foundation, which provides specialized investment management services. Other DAFs such as Link Charity, provide their services on a spread basis, where benefits and costs are shared between donors and the DAF. And, fees may not always be charged explicitly.

DAF Myths #6: Capital is being hoarded in DAFs

Some people criticize DAFs for hoarding capital that could otherwise flow directly to charities. Their argument is that capital is trapped in DAFs. But let’s remember that the capital that is supposedly trapped in DAFs is not sitting idle. Instead, its being invested in a variety of ways. Including investments in leading Canadian companies and increasingly towards impact investments that further the charitable missions of donors. The capital inside DAFs is not sitting idle. Quite the opposite. Capita inside DAFs is earning returns for the benefit of charities.

Also, consider the average granting rate from DAFs in 2021 was 9.8% of assets. This is almost twice the CRA disbursement quota for foundations. So DAFs aren’t hoarding capital. They are eplifying charitable impact.

DAF Myths #7: DAFs are expensive, or DAFs are cheap

When determining the value of DAFs, donors should consider their alternatives. What does it cost to obtain the services that DAFs provide from a 3rd party? Basically, to determine whether DAFs are expensive or cheap, we should compare them to private foundations. Instead of using DAFs, donors can create and operate private foundations to achieve similar philanthropic goals.

Of course, there are costs to setting up and maintaining private foundations. Many DAFs have already obsorbed these costs and obtained economies of scale as a result. This is one reason why DAFs are becoming so popular. And, unless you’re a skilled private foundation administrator, most smaller donors will find it easier to use a DAF instead.

However, when your pool of charitable financial capital is large, and your administrative capacity is high, then private foundations can often be more economical compared to DAFS. Our family office can help you determine whether using a private foundation or a DAF is best. Contact Us for more information.

DAF Myths #8: DAFs are profit centers for financial institutions (and that’s what’s driving their growth)

Wealth management firms are increasingly offering DAF services to their clients. This is because of their desire to maintain assets in-house. But also to make it easier to co-ordinate planning and administration for their clients. But overall, the assets inside wealth management DAFs remain relatively small compared to the wider range of assets they hold. Consider Canada’s largest bank owned brokerage firms. They manage hundreds of billions worth of client investments. But their DAFs “only” hold a few hundred million. In other words, DAFs assets at financial institutions represent a small portion of overall revenue those firms generate.

Our Family Office Perspective

Now that we’ve dispelled the common myths surrounding Donor Advised Funds (DAFs), it becomes clear that these philanthropic tools offer both flexibility and strategic advantages for donors of all financial backgrounds. Far from being exclusive to the wealthy, DAFs democratize the act of giving. DAFs allow individuals to provide charitable support more effectively in many cases. And, the notion that DAFs serve merely as tax havens or are exclusively beneficial to financial institutions is significantly overstated. The reality is that community foundation DAFs also play a crucial role in fostering a culture of giving.

Understanding the intricacies of DAFs is important for for donors. This includes their operational costs, tax implications, and the legal framework governing their use. For wealth investors specifically, our family office specializes in navigating these complexities. We offer bespoke advisory services that align with our clients’ philanthropic visions. Whether establishing a DAF, exploring private foundations, or seeking to refine your existing charitable giving strategy, we can provide advice.

We invite you to reach out to us for more information. Whether this is about how Donor Advised Funds can complement your philanthropic goals or other wealth management topics. Our goal is helping you make informed decisions that maximize the impact of your charitable contributions. Ensuring they align with your values and legacy aspirations.