Charitable giving certainly feels like it's at an all-time high. Whether it's high-profile celebrities giving away the bulk of their net worth, or a powerful corporation parting with a large gift, it's easy to assume that charities around the country are thriving. But that's not entirely the case, thanks to an increasingly popular phenomenon in charitable giving called donor-advised funds.

Acting as a sort of middleman between a donor and a charity, donor-advised funds, such as those administered by Fidelity Investments, Goldman Sachs, Charles Schwab, and Vanguard, allow individuals to make charitable contributions into a philanthropic fund and then recommend grants from the fund to specific charities.

These funds have become popular for a number of reasons. For one, they are practical: the approach allows a great deal of centralized control over charitable allocations, essentially letting individuals operate like their own mini foundations, directing funds to a number of different causes from a single hub. They also carry a huge tax benefit. Allocations into donor-based funds are recognized immediately as a charitable contribution, thus entitling the donor to a tax benefit on that year's tax return. However, there is no time limit on when the donor needs to recommend grants to selected charities from the fund.

So, in theory, a person can invest into a donor-advised account each year, immediately receive the maximum allowable tax deduction for that charitable contribution, but not release any of the funds to the underlying charities until some point in the future.

And that's where things could get a little dangerous for charities who are increasingly reliant on these donor-advised funds for their donations.

Ray Madoff is a Professor at Boston College Law School, where she teaches and writes in the areas of philanthropy policy, taxes, property and estate planning. Professor Madoff is the Co-founder and Director of the Boston College Law School Forum on Philanthropy and the Public Good, a non-partisan think tank that convenes scholars and practitioners to explore questions regarding whether the rules governing the charitable sector best serve the public good. She told me that this practice has become so commonplace that five of the top 10 charities in the country are donor-advised fund sponsors.

"What's happened is that, as people have become aware of the tax benefits, donor-advised funds are becoming more and more popular," Madoff told me.

Madoff says that, although people make donations to their donor-adviser funds with great intentions, they quickly get seduced by watching the money grow over time, even though once the donation is made, the money legally belongs to the fund, and the donor can't get their money back. Individuals get the feel-good moment of both savings and making a donation, and get the tax benefit to boot. Meanwhile, the fund administrator collects management fees on the money while it is parked in the account.

"Charitable giving is very difficult. It's hard to make a choice on which cause to support, and it's difficult to know if the money is being spent properly once you do make a choice," she said. "It's easier to bypass those tough decisions, and put your donation into an account and watch it grow - it actually feels better, even though the money isn't going to charity."

Because there is no time limit on how long the money can stay in the fund, some philanthropic organizations have begun to worry that the rise of donor-advised funds could lead to a delay charitable allocations. Despite funds' claims to the Washington Post that 90 percent or more of their investments are dispersed within 10 years, the IRS says that number is closer to just 10 percent.

Madoff pointed to a 2015 report by the Chronicle of Philanthropy, which found that giving declined 19.3 percent for education groups, 7.6 percent for social services organizations, and 5.8 percent for artistic and cultural charities in 2014, as possible evidence that donor-advised funds are having an adverse impact on traditional charities.

"No normal person would give $10 million to Fidelity and just trust them to do whatever they want with that money," Madoff said. "But in order to get the tax benefits, what we're doing is rewarding the setting aside of charitable dollars, instead of the flow of charitable dollars. Meanwhile, the individual gets to feel like they're making a contribution, without actually seeing it flow to charities."

So unless the government reevaluates how donor-advised funds are treated from both a functional and a tax perspective, Madoff says charities are going to continue to have a cash flow problem, and it's not hard to see why.

Published on: Sep 15, 2016