Donor-advised funds – do your nonprofit clients understand the risks?

Donor-advised funds (DAFs) have emerged as a powerful fundraising tool for nonprofits, reshaping the way individuals and groups engage in charitable giving.

DAFs provide a structured, tax-deductible way for donors to support nonprofit organizations. However, their rise presents both opportunities and risks for the nonprofit sector, one expert said Insurance Business.

Nicole Murphy (pictured), nonprofit directors and liability product manager at Travelers, pointed out that DAFs typically come in three forms: public institutions, national funds sponsored by financial institutions such as Schwab or Fidelity, and issuing organizations. one issue.

Non-profit organizations are private charitable organizations created to serve a specific community. These foundations allow donors to contribute in a variety of ways: cash, stocks, bonds, or non-traditional assets such as private equity, art, or Bitcoin. When donors contribute to these funds, they do so at fair market value.

“This is important because one of the benefits for the donor is that this is tax-free growth for the charity,” said Murphy.

Donor-advised funds – what are the pros and cons of nonprofits?

The appeal that DAFs offer to donors is primarily derived from the immediate tax benefits. Donors can significantly reduce their tax liabilities by donating assets to a donor-advised fund.

For example, if a donor has stock purchased for $6,000 that has reached $10,000, selling it will generally incur a capital gains tax on the $4,000 gain. However, by donating it to a DAF, the donor avoids capital gains tax entirely.

“It's a way for them to set up a fund managed by a sponsor, get a tax break, and advise where they'd like the money to go,” said Murphy.

The process is simplified: once the money is donated, it is no longer the property of the donor. This irrevocable transfer provides a clear line that can reduce potential disputes or misinterpretations regarding ownership or control of funds.

For non-profits, the benefits of donor-advised funds are reflected in the steady flow of donations they can generate. More money coming into the community foundation means more resources are available for charitable activities.

“A lot of sponsors stick to the same community base,” Murphy explains, “so the money keeps coming in, and you can attract more board members, staff and volunteers as it grows.”

However, managing these funds is not without its challenges. Nonprofits take on a fiduciary duty to manage funds wisely, which adds a layer of complexity to their operations. They must ensure that funds are invested properly, which requires expertise and oversight.

In addition, there is a risk that funds will be donated but not immediately spent on charitable activities. Donors can donate property and choose to “sit on it for a while,” Murphy said. This situation leaves the nonprofit in a holding pattern, with assets they cannot use immediately but are expected to manage and grow.

Another layer of complexity involves the privacy and data security implications of nonprofits managing donor-advised funds. Nonprofits must protect donor information, which is becoming a challenge in today's digital environment.

If a nonprofit organization lacks adequate online protection, it can be an easy prey for hackers, putting donor information at risk. The potential fallout from a data breach can be significant, both financially and in reputation.

Murphy highlighted this risk, noting that “nonprofits, especially small ones, may not have the resources to implement the cyber hygiene necessary to protect themselves from data breaches.”

How can your nonprofit clients manage the risks associated with DAFs?

Despite these challenges, Murphy pointed out that the growing popularity of fund-advised funds has not slowed down. He acknowledged that some nonprofits may feel compelled to set up donor-advised funds to compete for donations.

“Organizations that do not create a donor-advised fund may lose those that do,” he noted. Competitive pressure can drive small organizations to seek donor-advised funds, even if they are not fully prepared to face the difficulties and risks involved.

Looking ahead, nonprofits must navigate a delicate balance between the benefits and risks of donor-advised funds. On the other hand, these funds offer a unique opportunity to attract large donations and increase their financial base. However, they introduce a host of new obligations and risks, from managing complex financial assets to protecting sensitive donor data.

Murphy emphasized the importance of good governance and clear communication in managing these challenges.

“Having a clear purpose and culture that is communicated to employees and sponsors is important,” she said. “It's more important than ever to have an inclusive culture to attract employees, volunteers and donors.”

Broader trends in the nonprofit sector may also influence the future use of DAFs. Many non-profit organizations are moving towards accepting a wide variety of goods online, which requires robust systems to process and protect these transactions.

“The more transparency a nonprofit has when someone makes a donation, the better,” Murphy said.

This approach not only builds trust with donors but also ensures that nonprofits are better positioned to handle the challenges of donor-advised funding and other new fundraising strategies in the future.

Are you a vendor working for a non-profit? What is your opinion on sponsor-advised funds? Please share your comments below.