Understanding donor-advised funds: A comprehensive guide for nonprofits

Philanthropic giving plays a vital role in supporting the missions and operations of charitable organizations across the United States. In recent years, Donor-Advised Funds (DAFs) have emerged as a significant and rapidly growing mechanism for charitable contributions. In 2023 alone, grants from DAFs reached an estimated $54.77 billion. As donors increasingly turn to DAFs to structure their giving, it's crucial for both philanthropists and nonprofit organizations to fully understand how these funds work.

This guide will walk you through the essentials of DAFs, from their structure and benefits to actionable strategies for engagement.

Frequently asked questions

What is a donor-advised fund?

In the United States, a donor-advised fund (DAF) is best understood as a giving account established under the umbrella of a public charity that serves as a sponsoring organization. This sponsoring organization, which must be a 501(c)(3) public charity, takes on the responsibility of managing and administering the individual DAF accounts.

Key players in this process include:

• The donor, who makes an irrevocable gift and retains the right to recommend how grants are distributed and how assets are invested
• The donor advisor, often the donor themselves or someone they appoint
• The sponsoring organization, which maintains legal control over donated assets and has the final say on distributions (although it typically honors donor recommendations)

Types of sponsoring organizations include:

• Single-issue charities (e.g., universities, hospitals) focused on a specific mission
• Community foundations supporting geographic regions
• National charities (often linked to financial firms) that manage large volumes of DAFs for donors nationwide

Understanding these different types of sponsoring organizations can helps donors choose the right fund for their goals. Likewise, nonprofits can tailor their outreach and engagement strategies as the motivations and philanthropic focus of donors might vary depending on the type of DAF sponsor they choose.

What is the DAF process for individuals?

The overall process typically looks like this:

1. Contribution: Donors contribute cash, stocks, real estate, cryptocurrency or other assets to their DAF.
For individuals looking to utilize a DAF for their charitable giving, the donor first makes an irrevocable contribution. This contribution can take many forms, including cash, publicly traded securities like stocks and bonds and more complex assets such as real estate, privately held business interests and cryptocurrency. The ability to donate a wide array of assets, particularly appreciated assets held for more than a year, allows donors to potentially avoid capital gains taxes on the donated property. This is especially beneficial for donors with substantial holdings in non-cash assets who wish to maximize their charitable impact.

2. Immediate tax benefits: Donors receive an immediate tax deduction, even if the grant to a charity happens later.
Upon contributing to the DAF, the donor becomes eligible to claim an immediate tax deduction in the year the contribution is made. The extent of this deduction is subject to certain limitations based on the type of asset donated and the donor's adjusted gross income (AGI). This benefit serves as a significant incentive for donors to contribute to DAFs, potentially leading to a larger overall pool of funds available for charitable distribution.

3. Investment growth: Assets can grow tax-free within the DAF.
Once the assets are within the DAF, they have the potential to be invested and grow on a tax-free basis. Often, the donor is given the opportunity to recommend an investment strategy for their DAF assets from a set of pre-approved investment options offered by the sponsoring organization. This tax-free growth can substantially increase the amount of philanthropic capital available to charitable organizations, allowing the initial contribution to have an even greater impact over time.

4. Grant recommendations: Donors retain the flexibility to recommend grants to their favorite charities.
A defining characteristic of DAFs is that the donor retains advisory privileges. This means that after contributing assets, the donor has the ongoing ability to recommend grants from their DAF to qualified charitable organizations. This flexibility allows donors to separate the timing of their charitable contributions from the timing of when they want to support specific charities. They can contribute when it is financially advantageous and then take their time to research and identify the organizations they wish to support, recommending grants whenever it aligns with their philanthropic goals.

How does a charity typically receive funds from a DAF?

The grant process for recipient nonprofits is designed for simplicity and security:

1. Donor submits a recommendation via the DAF sponsor’s online portal.
The process of a charity receiving a grant from a DAF generally begins with the donor deciding to support a specific IRS-qualified public charity. Donors typically make these grant recommendations through an online portal provided by the DAF sponsoring organization. This online system allows donors to specify the amount they wish to grant and the recipient organization. The ease and convenience of this online recommendation process are significant factors in the popularity of DAFs.

2. Sponsoring organization verifies the recipient’s eligibility (501(c)(3) status with the IRS.
Once a grant recommendation is submitted by the donor, the sponsoring organization undertakes a process of due diligence. This involves verifying that the recommended recipient is indeed a qualified public charity in good standing with the IRS. Generally, DAF grants cannot be made to private foundations (with some exceptions for private operating foundations), political organizations or for purposes that would provide a personal benefit to the donor or their family. Therefore, for a nonprofit to be eligible for DAF grants, it is essential to maintain its 501(c)(3) status and classification as a public charity.

3. Funds are disbursed once approved.
Upon successful completion of the due diligence, the sponsoring organization will approve the grant recommendation and proceed to disburse the funds to the designated charity. Additionally, donors often have the option to specify the particular purpose for which the grant should be used or to make the grant in honor or memory of a loved one. It is important to note that DAF funds cannot be used to fulfill legally binding pledges made by the donor.

What are the benefits for US nonprofits that receive grants from DAFs?

Receiving grants from DAFs offers several significant advantages for charities and nonprofits. One key benefit is the potential for steady funding sources. Many donors who utilize DAFs often make regular, scheduled contributions to their funds and subsequently recommend grants to their favorite charities on a consistent basis. This predictability in giving can be invaluable for nonprofits, aiding in their budgeting processes and long-term financial planning.

Another substantial advantage is the potential for larger gifts. DAFs frequently hold significant amounts of philanthropic capital, and donors who have established these funds may be inclined to recommend more substantial grants than they might typically give through direct donations. The average balance in a DAF account can be quite considerable, indicating a substantial pool of resources that nonprofits can potentially access.

DAFs also offer a simplification of non-cash giving for both donors and nonprofits. Donors can contribute a wide variety of complex assets, such as appreciated securities, real estate and even artwork to their DAF. The sponsoring organization is typically well equipped to handle the liquidation of these assets, and the nonprofit ultimately receives a cash grant. For the nonprofit, this eliminates the administrative burden and complexities of accepting and liquidating non-cash donations directly, which many smaller organizations may lack the capacity to manage.

Furthermore, donors who utilize DAFs tend to be engaged and loyal supporters of the causes they care about. Research suggests that a high percentage of grants from DAFs are directed towards organizations that the donor has supported in the past. This propensity for repeat giving can foster long-term partnerships between nonprofits and DAF donors, leading to sustained financial support over time.

Finally, DAFs offer the potential for legacy giving. Donors can often name successor advisors or even designate specific charities as beneficiaries of their DAF upon their passing. This presents an opportunity for nonprofits to engage with DAF donors about their long-term philanthropic vision and potentially secure future support through estate planning.

How can charities effectively engage with DAF donors?

To help drive support from DAF donors, nonprofits should adopt a proactive and strategic approach.

1. Promote DAF giving

One fundamental step is to highlight DAFs as a valuable giving option in all fundraising materials and on the organization's website. This includes explicitly mentioning phrases like "Donate from your Donor-Advised Fund" in appeals and on the "Ways to Give" page of the website.

Even donors who have a DAF may not immediately think of using them for every charitable contribution, so clear and consistent reminders are essential.

2. Make it easy to give

Nonprofits should ensure it’s simple for donors to give through their DAFs. This includes clear and accessible instructions on how donors can recommend grants, and ensuring the organization's full legal name, Employer Identification Number (EIN) and physical address are readily available.

You can even consider incorporating DAF-specific giving tools or widgets on the website that streamline the grant recommendation process.

3. Thank donors sincerely

As with any donation, proper acknowledgment of DAF grants is also important in fostering positive relationships. Aim to thank both the sponsoring organization for the grant and if the donor's information is provided, the recommending donor for their generosity. While some DAF donors choose to remain anonymous when making grants, many opt to include their contact information with the grant recommendation. Encouraging donors to share their information is beneficial as it allows for proper acknowledgment of the gift and the opportunity to build a direct relationship for future engagement.

If you do send a personalized thank-you note to the donor, focus on the impact of their gift rather than sending a standard tax receipt, since the donor receives a tax deduction when they contribute to the DAF.

4. Promote recurring and planned giving

Since families are often involved in philanthropic decisions made through DAFs, nonprofits should consider strategies to engage families in their stewardship activities.

Likewise, encouraging recurring and planned gifts from DAF donors can help provide a stable and sustainable funding source. Promote the option of setting up recurring grants from DAFs and engage donors in conversations about including the organization as a beneficiary in their DAF's legacy plan.

5. Cultivate major gift prospects

Donors who give through DAFs often have a strong commitment to philanthropy and may have the capacity for significant contributions. It’s important, then, to cultivate major gift prospects among DAF donors, treating them with the same care and attention as other major gift prospects.

6. Build relationships with sponsors

Building relationships with sponsoring organizations, particularly community foundations, can also be highly beneficial. Philanthropic advisors at these organizations often work closely with DAF holders to guide their grant making decisions. By informing these advisors about the nonprofit's mission, programs, and impact, charities can potentially be recommended to donors seeking to support their specific area of work.

7. Share impact

Regularly sharing impact reports and success stories with DAF donors is crucial to demonstrate the tangible results of their contributions. Like all donors, those who give through DAFs want to see that their philanthropy is making a real difference in the lives of the people and causes they support.

8. Engage your team

Finally, nonprofits should engage their board members and volunteers by educating them about the significance of DAFs and encouraging them to identify potential DAF donors within their personal and professional networks. Leveraging these connections can significantly expand a nonprofit's reach to individuals who utilize DAFs for their charitable giving.

What information do charities typically need to provide for DAFs?

To facilitate grant recommendations from DAFs, nonprofits should have readily available:

• Legal name of the organization: This should match exactly with the name registered with the IRS.
  Employer Identification Number (EIN): This is the charity's unique tax identification number assigned by the IRS.
• Physical address: This is needed for the DAF sponsor to send grant checks.
• Contact information: Providing the name, phone number and email address of a specific development staff member can be helpful if the DAF sponsor or donor has any questions.
• Confirmation of 501(c)(3) status and public charity classification: While DAF sponsors will typically verify this independently, having documentation readily available can expedite the process.
• Bank account information for Electronic Funds Transfer (EFT): Offering the option for grants to be made via EFT can lead to faster and more secure receipt of funds.
• Clear indicators that DAF grants are accepted: Websites, social media and marketing materials should let in donors know that the organization welcomes gifts from DAFs.

Keeping this information updated on your website and fundraising materials ensures your nonprofit is easy to find and support.

Leveraging donor-advised funds for nonprofit success

Donor-advised funds are reshaping the philanthropic landscape—and nonprofits that recognize their potential will be better positioned for long-term success.

Understanding how DAFs operate, integrating DAF strategies into fundraising efforts and building meaningful relationships with both donors and sponsors, helps nonprofits unlock steady funding, larger gifts and loyal supporters.

Now is the time to embrace DAFs and maximize their potential to help amplify your mission’s impact across the communities you serve.