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Charities struggle as donor-advised funds balloon

Catherine Lane | E+ | Getty Images

Psst. Want to get a giant tax break and feel good about it? You may be in the market for a donor-advised fund.

Donor-advised funds—plans in which donors contribute to an account and take an immediate charitable deduction, distributing the money to charities over time—have been part of the charity landscape for years. Right now, though, they are booming, even as overall charitable donations are mostly stagnant.

Fidelity Charitable, a donor-advised fund run by Fidelity Investments, saw contributions increase 89 percent in 2012, according to The Chronicle of Philanthropy's latest ranking of top charities. It now ranks second only to the United Way. Meanwhile, contributions to the United Way rose less than 1 percent, and in a broader survey of charitable giving by the Giving USA Foundation, donations in 2012 fell well short of the peak in 2007.

The growth of donor-advised funds is potentially great news for charities—but there is a catch.

While money is flowing into donor-advised funds, considerably less is flowing out in the form of gifts to charities. In 2012, the funds took in almost $9.64 billion, but gifts to charities from the funds reached just $7.7 billion, according to a report by the National Philanthropic Trust. And the total payout from these funds, while higher than the average from foundations, is falling. It was 17.1— percent of assets in 2011, down from 17.6 in 2010.

(Read more: Why the wealthy don't give more to charity)

"There are no requirements that these funds give out money at all. Anything that's given is just because the donors wanted to. Philanthropic organizations are required to give out 5 percent, and some people think even that's too small," said Stacy Palmer, editor of The Chronicle of Philanthropy. "Fidelity and others are trying to do what they can, but they don't have a lot of leverage."

Donor-advised funds "aren't really charities, other than for their IRS classification," wrote Alan Cantor, a nonprofit consultant, on his blog.

Cantor argues that one reason the funds don't disburse more is that financial advisors are now promoting them to clients, and the advisors receive higher fees when assets remain in the funds. He cites a financial advisor who told him of a client who five years ago put $100,000 into a donor-advised fund, receiving an immediate tax deduction. Since then, he has directed just $1,000 to a charity, while the advisor has been receiving his fee on the funds that remain and his firm, presumably, has collected fees of its own.

"Advisors are recommending it and they can get paid on the assets under management in some cases. It's becoming much more of a mainstream part of estate planning," said Eileen Heisman, chief executive of National Philanthropic Trust, a charity that gives philanthropic advice to donors and also provides donor-advised funds.

(Read more: Who is family when it comes to estate planning?)

Even when money is ultimately given to a charity from a donor-advised fund, it can easily be given anonymously. That means charities often have no way of telling who the donor is, or how they might develop and build that relationship.

"It's really frustrating for charities because they feel like we're hiding them," said Heisman. "We're not, but a lot of donors want to be quiet. They don't want to shout it from the rooftops."

Still, donor-advised funds have plenty of fans. Melissa Berman, chief executive of Rockefeller Philanthropy Advisors, which advises ultra high net worth clients and institutions, says her clients particularly like the anonymity.

The funds are also especially attractive when markets are strong, since her clients will have plenty of capital gains to offset. Donor-advised funds make it easy for the recipients of such windfalls to sock away some or all of that money for philanthropy now, taking an immediate tax deduction that may even be larger than one from donating to an actual charity, and sorting out a giving plan later on.

(Read more: Time to buy pumpkins, set charity strategy)

"You can use a donor-advised fund to set the money aside, and come back when you have more bandwidth," she said.

And donor-advised funds are not just for the super rich. It is possible to create an account at Fidelity or Schwab with an initial investment of $5,000.

"In many of the small to midsize accounts, people are using a donor-advised fund for their annual giving. Fill it up, empty it out," Berman said.

(Read more: Millennials want to donate to charities, save the world, really)

The bottom line: Donor-advised funds offer plenty of advantages—to donors. But if you start one, think about having your money do some actual good sooner rather than later.

—By CNBC's Kelley Holland. Follow her on Twitter @KKelleyHolland.

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