ImpactAlpha, March 16 – The bipartisan Accelerating Charitable Efforts, or ACE, Act would “reform” the laws that govern donor advised funds, the tax-advantaged vehicles increasingly used by individuals and families to manage their charitable giving.
Proponents of the act believe that the money in donor advised funds, or DAFs, which often sits unallocated for years, should be used quickly and at a higher rate to produce greater societal benefits.
Increasing the capital available to create positive social impact is a laudable goal, and there are parts of the ACE Act that make sense—like taking away a private foundation’s ability to meet its 5% contribution requirement by moving money to a DAF. But many of the tactics proposed miss the mark – and an opportunity to put DAFs to work as impact investments, not just grants.
Funds should be doing good from the moment they are deposited in a DAF. But legislating higher payouts isn’t the answer.
In aggregate, DAFs already distribute significantly more than the 5% required of private foundations – nearly 24% in 2020, according to the National Philanthropic Trust. The Jewish Community Foundation of San Diego, where I serve as CEO, granted approximately $80 million in 2021. If the Ace Act were law, JCFSD’s granting would have increased by less than $100,000.
If the goal is to ensure that DAF assets are truly benefiting communities and individuals in need, legislation should instead focus on maximizing the positive impact all DAF assets can have on society – whether they are invested or distributed. Rather than focusing on grant distributions, as ACE does, legislation should consider how the remaining 75% or so of assets sitting in DAFs are invested.
The multiple challenges facing our nation, including affordable housing, health care, climate change 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 U.S. with a community foundation also has at least one Community Development Financial Institution, or CDFI. These are financial institutions like banks, credit unions, loan funds, and venture-capital providers whose mission is to offer sustainable financial services to low-income communities and individuals. DAF holders should be encouraged to invest in CDFIs. Donors often make large gifts alongside a “taxable financial event,” such as the sale of a business, and then direct the money to various charities over time. While the funds are sitting in the DAF, why not have them invested in a CDFI and effectively loaned out to small businesses or affordable housing projects in underserved communities?
The ACE Act provides some advantages to community foundations. It exempts funds under $1 million from any minimum distribution requirements, for example. While the act requires that contributions to DAFs at commercial sponsors be granted out within 15 or 50 years, depending on when the donor takes the charitable tax deduction, community foundations are empowered to offer a special DAF with an unlimited life, provided donors grant out at least 5% per year. This new DAF is similar to a family foundation but can only be offered by community foundations. Long-term DAFs are best-positioned to invest in CDFIs as these investments generally have at least a five-year horizon.
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% to 4%. But the historic default rates are near zero, making these investments secure and ideal options for using DAFs to generate positive impact prior to making a grant.
To encourage community foundations to foster partnerships with CDFIs and DAF holders to invest in them, legislation could offer an additional 4% 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%, which is more akin to returns on stocks and bonds. It would not be difficult for community foundations to provide annual statements to donors detailing their investments for IRS compliance.
The federal government recently granted $1.3 billion to CDFIs across the United States. 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 3% of the $41 billion in community foundation DAF assets were invested in CDFIs, the cost to taxpayers would be $50 million per year. As donors will have invested – not granted – their dollars, at the end of the investment period those funds could be granted to any nonprofit, multiplying the impact of the original contribution to the DAF.
Alternatively, the ACE Act might simply count investments in CDFIs toward the 5% distribution requirement, similar to the Program Related Investment allowance for private foundations. DAF dollars invested in CDFIs are not “warehoused” as some complain. Rather, they are dollars designated for good and leveraged through investment for greater impact.
Increasing impact capital supply and demand
Encouraging DAFs to invest in CDFIs is an easy first step. Most DAF holders invest their philanthropic dollars across asset classes. Legislation should define an impact investment and encourage DAF dollars to be invested in vehicles that meet the definition. 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.
This approach has additional benefits. 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. Donors would gain experience in impact investing and become more likely to engage with their non-philanthropic assets.
Mandating a 5% payout ratio on DAFs will have a negligible effect on actual dollars distributed into the community. Instead, to increase DAFs’ positive social impact, efforts to reform the laws that govern them should focus on incentivizing, or even mandating, that funds be invested for impact.
Beth Sirull is President and CEO of the Jewish Community Foundation of San Diego.