Measure on Donor-Advised Funds Misses Opportunity to Produce Genuine Societal Benefits

Proponents of the Senate’s Accelerating Charitable Efforts Act believe that the money in donor-advised funds should be doled out quickly and at a higher rate to produce the greatest societal benefits. I agree, funds should be doing good from the moment they are deposited in a DAF. But higher payouts aren’t the answer.

Most donor-advised funds already meet or exceed the IRS mandate of 5 percent for private foundations, even though some studies have shown a slightly lower rate among larger funds. The real issue shouldn’t be the exact payout number but whether the funds are truly benefiting communities and individuals in need.

To ensure that’s happening, legislation should instead focus on maximizing the positive impact all donor-advised-fund assets can have on society — whether they are invested or distributed. The surest way to do that is through impact investing, which is investing to generate positive, measurable social and environmental good alongside a financial return. Rather than focusing on grant distributions, as the so-called ACE Act does, legislation should consider how the remaining 95 percent or so of assets sitting in donor-advised funds are invested.

The multiple challenges facing our nation, including affordable housing, health care, and good jobs, all benefit from charitable giving, but they can be addressed at a much larger scale by investment dollars. Community foundations, corporate donor-advised-fund sponsors, and fund holders should be motivated to invest in local projects, small businesses, and community programs that will contribute to Covid-19 recovery and help address wealth and racial inequality.

Virtually every region of the United States with a community foundation also has at least one Community Development Financial Institution, or CDFI. These are financial institutions — banks, credit unions, loan funds, and venture-capital providers — whose mission is to offer sustainable financial services to low-income communities and individuals through vehicles such as small-business loans, mortgages, and financing for schools, community centers, and affordable housing.

Role of Community Foundations

Regulatory and administrative barriers make it difficult for CDFIs to take small investments from individuals. But community foundations can aggregate dollars from many fund holders to meet minimum thresholds and invest in CDFIs. The return on investment — interest paid on the loans from community foundations to CDFIs — will likely be a relatively low 1 percent to 4 percent. But the historic default rates are near zero, making these investments secure and ideal options for using donor-advised funds to generate positive impact prior to making a grant.

To encourage community foundations to foster partnerships with CDFIs and donor-advised-fund holders to invest in them, legislation might offer an additional 4 percent tax credit for each year donor funds remain invested in a CDFI. This would, in effect, bump the return on investment to 5 to 8 percent, more akin to returns on stocks and bonds — the likely alternative investment option for most donor-advised funds. It would not be difficult for community foundations to provide an annual statement to donors detailing their investments for IRS compliance.

The federal government recently granted $1.25 billion to CDFIs across the United States as part of Covid-19 relief funding. A modest tax credit would be a less costly way to move dollars to CDFIs and ultimately to individuals and businesses that need the funds. If, say, just 1 percent of the $142 billion in donor-advised-fund assets were invested in CDFIs, the cost to taxpayers would be $57 million per year. While donors will have invested, not granted, their dollars, at the end of the investment period those funds could go to the nonprofit of their choice — multiplying the impact of the original contribution to the donor-advised fund.

Encouraging community-foundation donor-advised funds to invest in CDFIs is a first step. Legislation could also define what type of impact investments would qualify and then apply the credit when donor-advised-fund dollars are invested in those vehicles. This would require a precise, enforceable definition of impact investment. But the tax code has thousands of definitions — coming up with one more shouldn’t be a problem.

Extra Benefit

This approach has an additional benefit. An influx of capital to impact investments would spur asset managers in all areas to create more investment vehicles focused on social good, thereby attracting more capital and generating more positive societal benefits.

If the proponents of the ACE Act want donor-advised funds to contribute more to the societal good, they should stop focusing on the 5 percent that would need to be granted to nonprofits every year and instead think more about what should be done with the remaining 95 percent of DAF assets. By investing in programs and projects that help communities, those funds could have a far greater impact than any minimal increase in the payout rate.