Donor advised funds are not trusts
A common misconception about donor advised funds is that they are trusts, charitable purpose trusts. At times, lawyers, especially those with expertise in trusts and estates, struggle with this distinction, as do donors. In 2023, this issue came to the forefront when Canadian charities briefly thought they might need to report on certain funds under trust reporting rules. Although donor advised funds have trust-like features, most are not trusts.
This fact has many implications for estate planning, as well as charitable effectiveness. It important to sort through the distinctions, limitations, and the paradoxes of the advised fund model.
Trust-like function and features
Donor advised funds look like trusts, but there are a few key distinctions. A trust must have three features or certainties: settlor’s intention to create a trust, property in the trust, and objects or purposes of the trust relating to beneficiaries. In common law, trusts are anchored in the settlor’s instructions and the protection of property. The trust structure provides legal certainty, even though it may be impractical or illusory. By contrast, donor advised funds are guided by recommendations and aligned charitable mission, not certainties or legal restrictions.
Donor advised funds are charity-owned funds that provide donors or designated fund advisor to make ongoing granting recommendations. Some foundations allow donors to name successor grant advisors. While donor advised funds may be structured as perpetual endowments, and hence, arguably trusts, most have flexible disbursement terms. Donations to donor advised funds are unrestricted and irrevocable. The host foundation owns the funds and may act on or reject a donor’s recommendations.
The promise of a donor advised fund is that the host foundation will approve the recommendations of donors — if they are consistent with the foundation’s charitable purposes and policies. In practice, this works out remarkably well for donors, especially during their lifetime. There is alignment.
Donor advised funds are simple structures to administer when there is a living donor or grant advisor. When a donor dies it become more complex.
Legacy Funds
It’s especially important to differentiate between trusts and donor advised funds for estate planning purposes. Donors are increasingly making large estates donations for multiple charitable purposes to foundations with donor advised funds. These funds may have successor grant advisors, for example children, but they are just as likely to have no ongoing successor advisor. If that is the case, the charitable advice provided by the donor, which is documented in a fund agreement or deed, is precatory and it falls to the foundation that holds the fund to make discretionary decisions. In fact, if there is no third-party grant advisor providing recommendations, the fund is not a donor advised fund, at least according to CRA’s definition.
Benefits of Legacy Fund
There are three major strengths of using a donor advised legacy fund for estate planning purposes:
The donor can easily update the terms of the fund without changing their will. This is because the fund is documented separately from the will. This depends on drafting of the fund agreement, as well as governance and policies of the host foundation. As noted, the fund must exclusively support charitable purposes that that are consistent the host foundation’s charitable purpose. The will makes the gift; the fund documentation provides charitable wishes.
Foundations with donor advised funds may exercise internal cy-pres. That is, unlike most trusts, there is broad power to interpret charitable purposes without reference to the public guardian or the courts. Again, the donor provides charitable recommendations – for grants and charitable programs – that are not legally binding. The host foundation has the legal ability to approve or deny. This makes reasonable variations of purpose viable.
Ability to address changing public needs or replace charities. Estate planning is an exercise in time travel. It’s not surprising that trusts and funds may have objects or wishes that, in time, become too narrow or complex to carry out exactly as written. Historic examples include fund to support water troughs for work horse or a cure for polio. But slight variations arise often. For example, there are insufficient funds, the community need has shifted; a charity has failed or is failing, or public policy has changed. A responsible foundation with donor advised funds will have charitable expertise and the capacity to make these decisions.
Risk of Donor Advised Funds
The biggest potential risk of donor advised legacy fund is a rogue foundation or a foundation without strong governance. Simply approving grant recommendations works well when there is a living grant advisor. But what happens when the donor is dead? What happens, as is increasingly the case, there is no successor advisor for the fund? What are the checks and balances? Who makes decisions and how? Donors and their legal advisors should ask these questions.
My view is a foundation has an obligation to embrace its fiduciary duties and develop strong systems to make discretionary decisions. While donors always have the choice of appointing successor grant advisors, typically it is more effective if the donor’s wishes are well documented and the foundation has policies and processes in the area, back by deep charitable knowledge. The foundation should be guided by the donor’s wishes and may make discretionary decisions. Money can’t be left in limbo. Checks and balances are needed to ensure money gets used for charitable purposes on an annual basis. Ideally, this is purpose-driven exercise.
With trusts, by contrast, trustees are limited by the deed and trust law in their ability to interpret and evolve the purposes. There needs to be an external reference to the courts or in jurisdictions like Ontario, the Public Guardian and Trustee. This legal brake creates bureaucracy and sometimes a culture that upholds the literal instructions of a long-dead settlor. It can produce a culture that focuses on risk management and protecting the past.
Looking for certainty
Donor advised funds are a paradox. The donor provides their charitable wishes, not binding trust restrictions. The foundation that owns the fund can reject these charitable wishes but, guided by good will and broad charitable purpose, will go out of its way to carry them out. Legacy donor advised funds are not shaped by legal restrictions, but of donor/foundation mission alignment. The foundation respects donor wishes and values, and acts as their proxy after their death. Donor advised funds are more flexible than charitable trusts, and that flexibility provides a greater capacity to deliver greater charitable impact in the future. Especially after the death of a donor/advisor, it is often more impactful because it responds to current needs in society at a future date. This system depends on strong foundation governance and charitable knowledge.
Charitable trusts provide the illusion of certainty, but over time, may be less likely to deliver it.