Ramstad: Donor-advised funds are growing. But if you have one, you should shrink it.

As baby boomers age into retirement and manage growing investment sums, their financial advisers increasingly recommend something called a “donor-advised fund” as a way to lower tax bills.

A DAF is kind of like a miniature private charitable foundation. A person can set up a DAF, put money into it and immediately take a tax deduction as if they had made a donation to a charity.

It’s a great strategy for wealthier people who are looking to lower their tax exposure. Trouble is, there are no rules to require distribution of the money to an actual charity. And many people just let the money sit.

Sometimes they forget about it. Sometimes they invest it to let it grow bigger. Sometimes they just can’t make up their minds where to direct it.

And depending on the firm that is administering the DAF, they may have given up their say over where the funds go.

“It’s sort of this peculiar institution,” said Jon Pratt, the retired longtime director of the Minnesota Council of Nonprofits.

Early in his career, Pratt led an initiative called the Philanthropy Project that examined every grant by a Minnesota foundation and ranked it on whether it was reaching intended beneficiaries. “It was pressure to influence what they were doing with their money and to pay attention to who’s benefiting,” he said recently.

Today, he and a California-based partner have relaunched the Philanthropy Project to call attention to money in DAFs that has already received the tax benefit of a charitable donation but hasn’t reached charities.

“This is not private property. Once you’ve got your tax deduction, the money is supposed to be a public benefit,” he said.

Some of the top administrators, or sponsors, of DAFs are community foundations, many of which do have guidelines to keep donors’ funds moving out the door. (Disclosure: The Minnesota Star Tribune’s new philanthropic effort includes a DAF sponsored by the Minneapolis Foundation.) Some nonprofit organizations, such as hospitals, themselves administer DAFs for people who want to concentrate their giving.

The largest, though, are the nation’s giant asset firms like Fidelity, Vanguard and Charles Schwab. They manage DAFs similar to the way they do investment and retirement accounts.

“If you have a 401(k), you look at it online, you can direct the investments and you’d like to see it grow. And if it goes down, you feel bad,” Pratt said.

“With the DAF, this is kind of proof of your generosity. And if it grows, that actually shows that you’re even more generous,” he said. “And so there’s this psychological effect of pride. And then people can turn almost scientific about their charitable contributions. So they’re waiting for the perfect contribution.”

Growing charitable assets is not itself a charitable act, however. It’s the turning over of that money to the charity that matters.

This is a message that leaders of charitable organizations have difficulty delivering to wealth benefactors with DAFs, at least according to some I’ve spoken with in the Twin Cities. They don’t want to anger donors, nor the foundations and other sponsors of DAFs.

Besides, data shows that DAFs distribute money at a higher rate than foundations, which manage about $1.5 trillion in assets nationwide and tend to stick to distributing the 5% of assets they are required to annually under federal law.

In 2022, the latest year for which data are available, DAFs distributed $54.8 billion, or about 22%, of $251.5 billion of total assets, according to National Philanthropic Trust, one of the nation’s largest managers of DAFs.

However, that means the other 78% is not doing much good. It’s trapped value. In the business world, there’s nothing investors dislike more than when executives at a company trap value.

In recent years, the Treasury Department and members on both sides of the aisle in Congress proposed rules or legislation that would disrupt the DAF model over concerns that too much money is parked for too long inside them.

The Accelerating Charitable Efforts Act, introduced by Iowa Sen. Charles Grassley in 2021, proposed a 15-year DAF that preserved the current tax break as long as funds were distributed within 15 years. For people who wanted to keep DAFs running longer, the bill proposed a 50-year DAF that provided tax breaks only when money was given to a charity.

Asset-management firms and some foundations, who treat the money in DAFs as akin to assets under management, have resisted regulatory changes.

But it’s not right for people to have been given a charitable tax break on money that hasn’t actually gone to a charity.

I know people with DAFs who are active managers of them, who use them smartly to lower taxes and generously to help charities. I admire them a lot.

If you’re wealthy enough to have set up a DAF, that’s great. You’ve done well, your heart is in the right place and you’ve taken advantage of the tax benefit the IRS offers.

Let charities benefit from your kindness now.