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Wall Street is sitting on billions meant for American charities

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Compared with many other wealthy countries, the United States relies a lot on charity. In the U.S., private donors help feed and house the poor, finance orchestras and museums, fund scholarships and universities – social functions that, in many countries, are paid for by governments and tax dollars. In return, the U.S. government offers generous tax breaks on the income that Americans donate to charity.

But some experts believe that changes in the financial industry are putting this longtime relationship at risk. In an article published Tuesday in The New York Review of Books, Ray Madoff, a law professor at Boston College, and Lewis Cullman, a 97-year-old philanthropist who has given much of his wealth to charity, argue that the rapid growth of a type of fund meant to collect, manage and distribute charitable donations on behalf of wealthy donors is obstructing the flow of money to those who need it most -- a claim the industry rejects.

Called “donor-advised funds,” the vehicles act as a sort of middleman between the donor and the charity that ultimately receives the money. Instead of giving money directly to the United Way or the Red Cross, a person can put their money in a donor-advised fund established by a financial firm, such as Fidelity Investments, Schwab, Vanguard or Goldman Sachs.

Cullman and Madoff's article does not provide definitive evidence that donor-advised funds are actually hurting America's charities. But they do put forward startling data showing that giving to donor-advised funds is skyrocketing, while contributions to traditional charities have declined.

Others in the field agree that the growth of donor-advised funds could be deleterious to charities. Daniel Borochoff, the president of CharityWatch, a group that evaluates and rates charities to help inform donors, has calculated that the growth of donor-advised funds could be delaying as much as $15 billion in aid to American charities.

“Our charitable resources are getting locked away," Borochoff said. "Particularly with the way our economy is, where a portion of the population is really struggling, really suffering and in dire need of charitable aid, it’s problematic for us to be taking $15 billion off the table for later.”

The key thing to know is that these donor-advised funds are legally considered charities; they file with the IRS as 501(c)(3) charitable organizations, just like the Red Cross or the Salvation Army. So when a person gives to Fidelity's donor-advised fund, the donor receives the tax benefit for their charitable donation right away, just as if they had given to the Red Cross. The difference is that a donor-advised fund can then hold the money on behalf of the client, disbursing it to different charities over time as the client requests.

The money legally belongs to the donor-advised fund, and the donor can't get their money back. However, funds let donors advise them on how to distribute the money to charities, and they can wait years or decades to do so. There is no time limit on how long the money can stay in the fund before it is given to a charity. In the meantime, the financial company collects management fees, and often invests the funds in stocks, bonds and other assets, so the account will collect interest and grow.

Donor-advised funds have been around for decades, but in recent years they have begun to dominate the field of charitable giving. In 2015, four of the 10 largest charities in the U.S. were technically donor-advised funds, while another organization in the top 10 relied heavily on those funds, according to an annual list compiled by the Chronicle of Philanthropy. And Fidelity Charitable Gift Fund, a donor-advised fund, is widely expected to surpass United Way Worldwide to become America's largest charity, perhaps this year.

As contributions to donor-advised funds have soared, giving to more traditional charities is declining, according to a 2015 report by the Chronicle of Philanthropy. Education groups saw private support fall 19.3 percent in 2014, according to the report, while private giving to charities performing social services dropped 7.6 percent, and giving to artistic and cultural charities was down 5.8 percent.

The issue, say Cullman and Madoff, is that people may choose to keep all or most of their money in donor-advised funds, where it is stuck in a kind of charitable limbo, instead of actually giving it to the needy. Unlike private foundations, which are legally required to pay out 5 percent of their assets each year, there are no rules on how much of the money in a donor-advised fund must be disbursed each year. These funds can hold money for years, decades or even centuries, Cullman and Madoff said.

Donors may have a psychological incentive to keep their money in the fund, since they’ve already collected their tax benefits from the donation, and they can watch the money grow over time and even gift control over the fund to their children or grandchildren. A donor might paradoxically feel good sitting back and watching this “charitable bank account” grow, even though charities have not yet received any money.

This arrangement benefits wealthy individuals, who have more flexibility in how they can donate and receive their tax deduction up front. Donors can also give stock or appreciated assets to the funds, like a yacht or an ownership stake in a business -- donations that small traditional charities are ill-equipped to deal with. The arrangement also benefits financial firms, which have a new source of revenue. But according to Cullman and Madoff, charities and American tax payers lose out.

This money put in donor-advised funds will likely go to charity eventually, said Borochoff -- it can't be used to do anything else. But in the meantime, traditional charitable organizations could lose out on funding, and financial companies will collect profits.

The companies that have set up donor-advised funds, like Fidelity and Schwab, object to this view. They argue that donor-advised funds help increase charitable giving, since they make the process easier and more accessible. They also say that the ability to separate the initial contribution to the fund from the actual grant to the charity allows donors to support a wider variety of organizations and causes, and give money throughout their retirement.

Matt Nash, a senior vice president of donor engagement at Fidelity Charitable, said in an interview that donor-advised funds allow people to be more thoughtful about their giving over time, and allow more money to go to charity, since donor-advised funds make it easy for people to donate complex assets and securities to the funds, as well as money. “Our donors, when we survey them every year, two-thirds of them tell us that they give more away to charity because they have this account than if they didn’t have this account,” said Nash.

Kim Laughton, the president of Schwab Charitable, said that some of their donors contribute small amounts frequently and grant out a majority of their account balance in a single year, while others make larger contributions periodically and then grant the money out over a longer period time. "Both of these strategies are an important source of support for the charitable sector," she said.

It’s not exactly clear how donor-advised funds have altered the amount of money given to charities each year. In an interview, Madoff said that the level of charitable giving has remained about the same in the U.S. over time – about 2 percent of disposable net income. Meanwhile, the amount of money given to donor-advised funds has surged, from 2 percent of total giving among the country’s biggest 400 charities in 1991 to 18 percent in 2015.

“We know that donor-advised funds are becoming the dominant vehicle for charitable giving. And we know that overall charitable giving is staying the same,” says Madoff. “If every dollar that came in went out, you wouldn’t worry about them causing a problem. The question is, how much money is going out? If it’s less than 100 percent, then you have less money going to charity.”

The percentage is extremely difficult to figure out, since financial companies, third parties and the IRS tend to use different metrics for calculating it. Schwab Charitable said in an email that more than 90 percent of contributions into its accounts are fully distributed to charity within 10 years, while Fidelity Charitable said that 92 percent of donations in its giving accounts were distributed to charities within 10 years of receipt. Vanguard Charitable said that it grants nearly 20 percent of its assets under advisement to charity on a five-year rolling basis.

However, IRS statistics put the median payout rate for donor-advised funds at only 10 percent of the total value of the fund in 2012.

Cullman and Madoff argue that the deal is a bad one for taxpayers, too. Americans claimed nearly $200 billion in charitable tax deductions in 2013, according to the Urban Institute. The U.S. offer these tax deductions to encourage giving to charity. But what if that tax-free money is now just sitting in an account at a financial institution?

“When we think of charitable donations, we tend to focus on the generosity of the donor and think that it is not our business where the charitable donations go," Madoff said. "But if you focus on the fact that these donations cost the government billions of dollars of taxes that it otherwise would have received, you realize that the American public has every reason to ask what the public is getting from these charitable donations."

It’s prudent to check out any charity before donating money. Here are five tips to remember before you decide to give. (Video: The Washington Post)

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