May 17, 2024 - Business

The mystery of DAF fees

Illustration of M.C. Escher hand drawing another hand holding a stack of money

Illustration: Sarah Grillo/Axios

Charitable funds are paying financial advisers millions of dollars in advisory fees — and the IRS wants to crack down on those agreements.

Why it matters: One of the big secrets in the world of philanthropy is how much money flows back to donors' financial advisers after being given away to charity.

  • Help us reveal that secret by filling out this form.

The big picture: For financial advisers, it can be bittersweet when their clients give money or assets away to charity.

  • On the one hand, the client gets a big tax write-off — but on the other hand, they no longer pay their financial adviser for managing those assets.

Yes, but: When the charity in question is a donor-advised fund, or DAF, the advisers often get to keep on being paid (by the DAF) for managing the money. (DAFs),

  • DAFs allow Americans to take charitable tax deductions before deciding where they want the money to end up.
  • DAFs don't spend the donated money, they just sit on it until the donor decides where it should go — and that can take years. Many DAFs are designed to exist in perpetuity.
  • So long as there's money in the DAF, advisers can charge for determining where it should be invested.

Driving the news: These quiet arrangements are getting more attention now: The IRS recently proposed an excise tax on those management fees, in a move that drew broad ire from the DAF industry at a hearing this month.

Follow the money: Contributions to DAFs doubled between 2019 and 2022 — from $42 billion to $86 billion.

  • Chuck Collins at the Institute for Policy Studies tells Axios the main driver of that growth is probably flows from donors following the advice of professional financial advisers.
  • As WaterStone, a Christian charity platform that runs a DAF, wrote in a comment letter to the IRS, "having a broad investment advisory platform is crucial to WaterStone … in order to attract more contributions."

The catch: The IRS has various problems with this setup, including:

  • Advisers have a clear incentive to encourage donations to a DAF over donations directly to a public charity.
  • Because the adviser is paid a percentage of the funds being managed, they have an incentive to advise against actually distributing the money to charity.
  • The donor might be able to direct their tax-free money in the DAF to be invested in ways that benefit their own interests. And advisers can similarly direct the money to be invested in their own firm's funds.

Where it stands: In its own comment letter, the Securities Industry and Financial Markets Association pushes back on the arguments by saying the IRS has provided "no data or other empirical evidence to support any of these reasons/potential conflicts."

  • In other words: Because these advisory contracts are kept confidential, there's no concrete evidence they're being abused; therefore, they shouldn't be taxed.

Between the lines: Steven Woolf, a former tax policy lawyer at the Jewish Federations of North America, tells Axios that the IRS' proposed excise tax isn't necessary, because under existing IRS rules, an excise tax is already payable when the fees involved exceed "reasonable compensation."

  • What's very unclear, however, is where that line is drawn.

By the numbers: Fidelity Charitable, the largest DAF, says in its "policies and guidelines" document only that the fees it pays should be "mutually agreed-upon and reasonable."

  • When Fidelity (the for-profit company) manages the funds, the fees it charges can range as high as 0.91%, so clearly a fee that high is sometimes considered reasonable.
  • Do outside-adviser fees range higher than that? No one is saying.

The bottom line: The amount of money that advisers make from money that has been donated to charity remains highly opaque. So we've decided to ask clients directly — which might include you. We don't need to know how much money you have, just the percentage of total assets that your financial adviser is charging your DAF.

  • Help us out by filling out this form or sharing it with your rich friends.
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