The first donor-advised fund was established by the New York Community Trust in 1931, but it would be almost forty years, and the passage of the Tax Reform Act of 1969, before donor-advised funds received formal regulatory recognition from Congress. A decade and a half later, the Tax Reform Act of 1986 — which imposed, in some administrative areas, "more stringent reporting obligations and payment deadlines on private foundations" — established DAFs as an attractive giving vehicle for a certain kind of donor. Then, in 1991, Fidelity Investments established the Fidelity Charitable Gift Fund as an independent public charity, and the DAF landscape was changed forever.
Over the course of the 1990s and 2000s, the debate over donor-advised funds grew more heated, with critics of commercially sponsored DAFs arguing that because "charitable donations can be held in a DAF for decades or even centuries," they should be more tightly regulated, while others defended them as "an efficient, 21st-century alternative to the private foundations that dominated philanthropy in the 20th century...easy to set up and inexpensive to manage."
Recently, PND spoke with Kim Laughton, president of Schwab Charitable, a nonprofit donor-advised fund provider established with the support of Charles Schwab & Co., about her fund's results for the fiscal year just ended and what she makes of the persistent criticism of commercially sponsored donor-advised fund providers. Prior to joining Schwab Charitable, Laughton held a variety of leadership, strategy, and general management positions at Charles Schwab & Co., served as a vice president for Citibank-Asia/Pacific, and worked as a Consultant for Bain & Company.
Philanthropy News Digest: In a report released at the end of July, Schwab Charitable announced that for the fiscal year ending June 30, it distributed more than $1.2 billion in grants to charities from its donor-advised funds under management. That's a 12 percent increase over the amount it distributed in the prior fiscal year, and the second consecutive year in which it has distributed more than a billion dollars in grants to nonprofits and charities. Given the volatility in the stock market over the last year and a half, were you surprised by the results?
Kim Laughton: I wasn't. The markets were volatile over that period, yes, but from beginning to end, they were fairly flat. In between, there were two swings of 15 percent or more, in August last year and then again in January this year. Whenever that happens, there is going to be uncertainty, and you do find that people tend to become more cautious in terms of their charitable giving. But the wonderful thing about donor-advised funds is that people have already set aside an amount of money for future giving, and we find that giving from our funds stays pretty robust, regardless of the economic climate.
Factoring in the Great Recession and its aftermath in the 2008 to 2010 period, we saw increases in granting as well. Not much as the 12 percent we saw in fiscal year '16, but in the worst of that period, between fiscal year '09 and '10, our granting actually increased about 2 percent. And, again, that underscores how donor-advised funds tend to stabilize giving in difficult times while being a great way for clients to be thoughtful and proactive in their giving in good times.
PND: What was the average payout for the donor-advised funds under your management in fiscal year 2016, and how does that compare to the previous year?
KL: The average payout for our funds for the last two fiscal years has been fairly steady at around 20 percent. It was slightly higher this last year because our assets actually grew a bit less than our granting. Of course, we're extraordinarily proud of those rates. As you know, private foundations operate with a mandated 5 percent payout, so we've been averaging four times the mandated minimum that foundations pay out. The other statistic that's important to think about is that our clients, over a fifteen-year period, grant out 90 percent of what they put in to their funds, and over a five- to ten-year year period they grant out something like 76 percent. In other words, a lot of our clients are contributing to their funds on a regular basis, and they're granting dollars from those funds at a very active rate.
PND: I suspect a lot of people reading this don't know how a donor-advised fund administered by Schwab, or one of your competitors, works. Can you explain that to us
KL: Sure. The way I like to explain it is that donor-advised funds are specialized accounts for charitable giving, much like IRAs or 401(k)s are specialized accounts for retirement planning, or 529 plans are specialized accounts for college savings. The way it works at Schwab is that you open an account — it could be a retirement account, a college account, an investment account, or a bank account — and all those accounts appear when you log into site as part of a dashboard display.
Now, if you decide to open a charitable account, it is added to your dashboard, and you see it every time you log in. Of course, you have the ability to transfer money from your other Schwab accounts, or from outside accounts, into that account, and some people will transfer assets like appreciated securities into their accounts. Appreciated securities that have been held for more than a year receive long-term capital gains treatment, and if you transfer them to a charity — and Schwab Charitable is a charity — the charity does not pay tax on the capital gain. So a very typical use case for our funds is that on a fairly regular basis clients will look at the most appreciated securities in their portfolios, maybe an investment that has run up and become a larger share of their portfolio than they're comfortable with, and instead of selling those shares and having to pay the capital gains tax, they'll transfer the shares to their charitable account and dedicate the proceeds to charitable purposes.
Once an individual has opened a charitable account with us, they can invest the funds in a range of things, from simple money market funds to alternative assets such as hedge funds and private equity. If they've got a large balance in their account, they can even recommend an investment advisor to oversee the management of their account. And at any time point in time they can recommend a grant to their favorite charity. As long as they're granting to a 501(c) (3), which is the only kind of organization we grant to, they will be granting directly to that charity.
So let's say I want to make a $500 grant to my local food pantry. I go into my online account the same way I do when I log into my other Schwab accounts, and I recommend that grant. If I've already given to that food pantry before, or someone else at Schwab Charitable has given to it, it'll pop up on the screen when I type in its name and, with a couple of keystrokes, I submit the recommendation. We will approve that grant as long as it's a legitimate 501(c)(3); we do have a due diligence process in place, and the vast majority of donor grant recommendations are approved fairly quickly. After the grant has been approved, a check with an acknowledgement letter — Schwab donors can choose whether they want to be acknowledged and how they want to be acknowledged — will be sent to the charity, which can then acknowledge the donor in whatever way they choose. In the meantime, all this activity is consolidated under one account, so you have a record of all your giving right there. It's easy to see the last time you recommended a grant, and it's easy to set up recurring grant payments, whether it's every month or every year — you just set it up, and the funds automatically go out. And you can do all that via your smartphone, so if you're at a charity auction or something, you can use your phone or tablet to make grants on the fly.
PND: Critics of donor-advised funds point out that charitable giving in the U.S. has been stuck at 2 percent of GDP for almost forty years. At the same time, we've seen explosive growth in the number of private foundations in the U.S. and in the use of donor-advised funds, which has led some to suggest that that growth in DAFs and private foundations is coming at the expense of giving to nonprofits that work directly in communities providing frontline services. How do you respond to that criticism?
KL: That's a criticism I just don’t agree with. First of all, as far as the 2 percent of GDP dedicated to charitable giving goes, we believe the donor-advised fund industry is partly responsible for helping to grow that 2 percent. If you go back to 1975, the percentage of GDP going to charity has ranged between 2 percent and 2.4 percent, and going from 2 percent to 2.4 percent — which is where we were in 2000 right before the dot-com bubble burst — is pretty dramatic. I think our industry can take some credit for that, and I feel good when we see incremental increases in that number, as we often have in non-recessionary years, to 2.2 percent or 2.3 percent.
But in terms of donor-advised funds overall, it's important to realize that we are still a very small part of the larger charitable giving ecosystem. Giving last year was somewhere around $320 billion. Donor-advised funds accounted for just $19 billion of that, or between 5 percent and 6 percent of total charitable giving. So, we're a small part of a big, complex ecosystem. Private foundation endowments are probably four or five times our size.
Are we providing a valuable service to donors? I think so. In fact, 65 percent of Schwab Charitable donors say they give more to charity than they otherwise would because we make it easy for them. And we're way more cost-efficient than a private foundation or a donor-advised fund at a community foundation. So we feel pretty strongly that we're a positive force in the charitable giving ecosystem, and we also feel that, over time, we will help more people see charitable giving and charitable planning as part of their regular wealth management activities, instead of it being an afterthought. And that, in turn, will help grow the 2 percent of GDP number.
PND: Over the last few years, we've heard critics of the donor-advised industry call for legislation that would impose a mandatory payout rate on DAFs and/or establish a time limit for the distribution of funds from donor-advised funds. In your view, do those proposals address real problems?
KL: I already quoted you our payout rates, and if you were to take the 5 percent payout rate that private foundations are subject to and applied it to donor-advised funds, we'd have no problem with that. Now some community foundations might have a problem with it, because some of the donor-advised funds they manage aren't nearly as active the accounts we manage, but I can't speak for them.
Generally speaking, I do believe the two things you mentioned are solutions in search of a problem. The concept of limiting the life of a donor-advised fund misses the point of why people use them. At least at Schwab, it's the rare sort of donor-advised fund that is dormant, and the rare person who has sort of forgotten about his or her account and is not giving the money to charity. There's no magic number. Some people will contribute and make grants every year. Others may have a one-time wealth event, like taking a company public or receiving a huge inheritance, that ends up funding their giving over a long period of time. So, trying to decide how long a donor-advised fund should last is a problematic exercise, and again, as long as donors are actively distributing funds from their DAFs, I don't think it's something lawmakers need to worry about.
That said, I do believe the criticism and misperceptions of our industry have come from people who seem opposed to the concept of providing donor-advised fund holders with a tax deduction and not requiring them to give to charity at a commensurate level in the same year. I also think it's because donor-advised funds have grown fairly rapidly in terms of their popularity, even though, as I mentioned, we're still a small part of the giving ecosystem. We are not where you go to find resources to address major problems.
At the end of the day, all the commercial donor-advised fund providers publish annual reports, we're very transparent on our 990s, and we're not trying to hide anything. So we'll continue to talk to the press as honestly as we can, to do presentations, to respond to criticisms of our industry, and to do our best to clear the air. That's all we can do.
— Mitch Nauffts