A client wants to give money to charity on a regular basis, but doesn't know which legal vehicle is best. His advisor recommends donor-advised funds because he's familiar with them. Or, maybe the advisor has experience setting up private foundations and convinces the client to go that route.

In either case, the client doesn't understand the pros and cons of these charitable vehicles. For instance, the client who set up a private foundation may not have understood all the reporting requirements. The client with the donor-advised fund might have never realized the limited control it provides over charitable donations.

At some point, the client realizes he or she made the wrong choice. Why? The advisor didn't carefully assess their needs.

"A lot of times people create these donor-advised fund [accounts] because they think they're easier," says Douglas Mellinger, vice chairman and founder of Foundation Source, a Fairfield, Conn., advisory fund. "We get phone calls from people every week in foundations who want to do things and are told that they can't."

Still, Mellinger says he likes donor-advised funds when they are appropriate-when the account is under $500,000 and when the client doesn't expect much control over the investment.

Private foundations are as old as the hills. They have been around for centuries, while donor-advised funds have been around for a few decades.

A donor-advised fund is simply a pool of charitable assets, according to Foundation Source. The fund is typically offered by a public charity that is usually affiliated with a local community foundation or a big investment company. Examples of the latter are funds offered by Charles Schwab, Fidelity and Vanguard, among others.

The Vanguard Charitable Endowment Program, for example, was founded in 1997 as an independent, nonprofit organization overseen by independent trustees. Vanguard provides certain investment management and administrative services to the program.

A private foundation is a non-governmental, nonprofit that is typically established and funded by an individual, family or entity. Activities are usually limited to making grants. And those making the grants are limited to small groups of people or maybe just one person. 

Foundation Source's Mellinger says the key issue is control. Most clients want it, he says. With private foundations, he says, clients can control investments, tax issues and whom the foundations hire, which can ensure relatives have jobs.

Why have the controls of the private foundation vehicle? Mellinger says private foundations have these features not available in donor-advised funds. Foundation donors can expand grant making beyond IRS approved charities, they can also engage their families in the philanthropy and hire the staff.

Donors in private foundations, he adds, can champion their own causes, viewpoints or philosophies, Mellinger notes. But with donor-advised funds, less is more, advocates say.

Kim Wright-Violoich, president of Schwab Charitable Giving, agrees that control is sometimes important, but she says that's not the only factor that goes into deciding on a charitable vehicle.

"It's also an issue of control versus complexity," she says. Private foundations, she adds, provide more control but they also require more administrative oversight for things such as tax filing requirements. A donor-advised funds "has much fewer administrative burdens," Wright-Violoich says. Indeed, the donor-advised fund's staff handles all grant research and reporting. But in the private foundation, these are the responsibility of the donor.

Donor-advised funds also provide donors with anonymity, adds Sarah Libbey, president of the Fidelity Charitable Gift Fund.

Grants can be made anonymously using a donor-advised fund, while private foundation grants are matter of public record. But here again, the competing charitable vehicles offer different approaches. Vanguard's donor-advised fund will not make grants to individuals while grants are allowed to individuals under the private foundation format.

Another issue for clients to consider is cost. More administration means more expenses, meaning donor-advised funds are typically cheaper to run, says Wright-Violoich.

For example, according to Vanguard, there are no startup costs for their fund and no excise costs. Private foundation must pay excise taxes from annual net investment income. There is also no annual IRS 990-PF form for the donor-advised fund, but there is such a requirement for the private foundation, according to Vanguard.

Yet some say private foundations are becoming more affordable. Mellinger of Foundation Source says at one time donor-advised funds were clearly the cheaper alternative. Now, however, outsourcing and other economies of scale have made private foundation cost competitive with donor-advised funds.

Foundation Source, examining fees for a $1 million account, concluded that the average expenses for a private foundation were 1.43% of assets. This compared with an average of 1.40% for eight prominent donor-advised funds.
On an individual basis, however, some donor-advised funds are clearly cheaper than private foundations. Vanguard, for example, charges 0.73% of assets for its donor-advised fund. Schwab and Fidelity-which together with Vanguard hold 90% of the donor-advised fund market-were also below the private foundation expense average.

Over a decade, a $10 million charitable account could save an average of $1 million in fees by being held in a donor-advised fund rather than a private foundation, according to Vanguard.

The difference between a foundation and a donor-advised fund is analogous to the difference between a separate account and a mutual fund, says Foundation Source's Mellinger.

In a mutual fund, the investor must accept all decisions of the fund company and its manager, regardless of the effect on an individual portfolio. In the separate account, the client can have a big say in how the portfolio is set up, how taxes are managed and other matters. The foundation has these same control advantages over the donor-advised fund.

"With a donor-advised fund, donors set up a charitable account and contribute assets, which are then administered by a third-party fund," according to Foundation Source literature. "The donor's role is that of an advisor, rather than a decision maker." 

Mellinger adds that fund directors make all the final decisions on which charities receive how much money from a donor-advised fund.

Barnes, who says the solution for some clients is to use both options, says the correct option depends on the needs of clients. Advisors also need to be aware that these needs can change.

"Say a husband and wife set up a foundation and the husband really was enthusiastic about running the foundation but the wife isn't interested," he says. "The husband dies and the wife doesn't want to run things. Then the best option is to convert to a donor-advised fund."

It's common to see donors attempt to switch from one charitable vehicle to another. Wright-Violich says she often hears from people in small foundations, say $250,000 in assets or less, that expenses are too high and administrative burdens are daunting. The expenses, she adds, are becoming more of an issue due to the bear market. With asset size declining, the average expense basis for small foundations becomes a headache, she warns.

Wright-Violoich gives clients seeking to exit foundations the following plan for converting to a donor-advised fund:

1. Adopt a plan of dissolution. If necessary, notify the state authorities, such as the state attorney general, of the dissolution.
2. Give all of the foundation's assets to a donor-advised fund by distributing the assets to one or more 509(a)(1) public charities that have existed for at least five years.
3. File a Form 990-PF for the taxable year in which final distributions are made and check "final return" at the top of the form.
4. Submit any final state regulatory or tax filings.

In weighing the merits of donor-advised fund versus private foundations, experts on both sides agree on this: Advisors who fail to put their clients in a suitable vehicle are running the risk of seeing their disappointed clients take their assets elsewhere.