January 1, 2001

Gift Giving

Clients with appreciated securities and a philanth

Illustration By Christophe Vorlet

We all know that it's better to give than to receive. But advisors are catching on to a charitable giving strategy that helps clients feel good about doing both. By gifting appreciated securities to donor-advised charitable gift funds offered by Fidelity Investments, Charles Schwab, Vanguard, T. Rowe Price, and Eaton Vance, among others, clients can fulfill charitable goals, eliminate capital gains taxes, and receive tax deductions to boot.

The booming stock market of the past couple years has left many clients holding appreciated securities, and Americans' passion for philanthropy continues unabated. According to a recent report by the Council of Economic Advisers, Americans donated more than $190 billion to charity in 1999, a 41% increase over 1995. So it's not surprising that donor-advised funds are becoming increasingly popular among advisors.

These funds have also captured the attention of folks in Washington. A legislative proposal that first appeared last year in the President's budget designed to "encourage the continued growth of donor-advised funds" and create best practices for charities operating these funds is still being kicked around on Capitol Hill. Community trusts and foundations - the first groups to offer donor-advised accounts - have questioned whether financial-services companies should be allowed to offer donor-advised funds. These groups have pushed for legislation that would create a uniform playing field, so potentially bad practices would be punished. One practice that community foundations and some advisors object to is paying commissions, as Fidelity and Eaton Vance do, for referring clients to their donor-advised funds.

The IRS gave fund companies permission ten years ago to establish charitable intermediaries and manage and market donor-advised funds. Fidelity was first out of the gate in 1992 with its Charitable Gift Fund. And in October 1999, the company launched the Charitable Advisor Gift Fund, which includes the Fidelity Advisor Funds and offers a 25 basis point fee to commission-based advisors who refer clients to the fund.

Cynthia Egan, president of Fidelity's Charitable Gift Fund, says the time for donor-advised funds has come. "Donors want to be involved in some fashion with contributions. We think of it as 'living giving.' Donor-advised funds provide organized giving over clients' lifetimes." Egan says Fidelity launched the advisor gift fund to readily accommodate the large numbers of clients working with professional advisors. As for the 25 basis point fee, she says the advisor fund is new, and when critics take a look at the fund's cost effectiveness, and the amount of money it's generating for charity, they'll likely change their tune. In 1999, Fidelity's Charitable Gift Fund (which includes donations from the advisor fund) raised $870 million, and gave out $453 million to charitable causes, Egan says.

Susan Frunzi, a partner with the New York law firm of Schulte, Roth and Zabel, says the attacks on fund companies that provide a broker commission to refer clients to their charitable funds is overkill. "They are providing a means to invest the money and get it to charity." Indeed, other fund companies are catching on to the donor-advised fund trend, and have recently launched their own funds. Vanguard's Charitable Endowment Fund opened for business in 1998. Eaton Vance began its U.S. Charitable Gift Trust last June, while T. Rowe Price launched its Program for Charitable Giving in October 1999. Schwab's Fund for Charitable Giving has been accepting contributions for about a year. And SEI Investments and Oppenheimer Funds are expected to roll out their own soon.

"Donor-advised funds are an easy and quick option to really incorporate philanthropy into a client's overall financial planning strategy," says Melissa Cliett, director of philanthropic advisor services for the Council on Foundations, a membership association representing 2,000 grant-making foundations and 400 community foundations in the United States. "A lot of people have a charitable intent, and now they have the financial wherewithal to match their charitable mission," she says.

Imagine a client rushing into your office on December 27 and announcing she wants to give to charity and reap some tax benefits before the new year by starting a private foundation with appreciated securities. Cliett notes that "it would take longer than three days to do it" because the foundation must first be incorporated, the Internal Revenue Service must issue a tax exemption, and there can be lots of legal maneuvering. But clients could immediately make an outright gift of appreciated securities to charity through a donor-advised fund. "People often want to make a charitable contribution at the end of the year to get a tax deduction," says Frunzi. "Donor-advised funds are the perfect way to go."

But when deciding between these two options (and they aren't the only two), the advisor must consider the client's charitable intent, because unlike foundations, the donor loses control of the assets in a donor-advised fund. However, donors can decide how the proceeds are reinvested, and determine when and where the charitable grants will go.

And by donating appreciated stock owned for more than one year instead of cash, a client can gain a deduction for the full market value of the stock and avoid paying capital gains tax on the appreciation. If the client sells the stock first, however, she would have to pay tax on the appreciation and would wind up with a smaller gift, and a smaller deduction.

Donor-advised funds are perfect for clients unsure of which charity they'd like to support because they're not required to make grants immediately. Instead, donations can be ladled out over time. "Even though the grants won't be made immediately, you're getting the benefit of an accelerated tax deduction," says Jack Brod, principal of asset management and trust services at Vanguard. Some exceptions apply, however. Deductions on donations of appreciated securities are limited to 30% of adjusted gross income; for cash, it's 50% of adjusted gross income.

Brod cautions advisors using appreciated securities in donor-advised funds to always "determine whether they are long-term capital gains or short-term capital gains." For instance, say a client recently bought a stock at $10,000. A few months later it is worth $30,000, and the client now wants to donate it to charity. The tax deduction will be based on the $10,000 basis, not the higher current market value.

Getting Into the Act
Donor-advised funds have a rather long history, though for most of their existence community charitable groups have run them. Over the past few years, however, spurred by the long bull market and some legislative initiatives in Congress, the big mutual fund companies have started their own funds. Here's where you can go on the Web to get details on those companies' donor-advised offerings.

Fidelity's Charitable Gift Fund

www300.charitablegift.org:80

Vanguard's Charitable Endowment Fund

www.vanguardcharitable.org

Eaton Vance's The U.S. Charitable Gift Trust

www.charitablegifttrust.org

Charles Schwab & Co.'s Fund for Charitable Giving

www.schwabcharitable.org

T. Rowe Price Program for Charitable Giving

www.programforgiving.org

The history of donor-advised funds stretches back to 1914, when several community foundations started by banks launched these vehicles. Big mutual fund companies now accept donations of stock and bonds, Some, like Vanguard, will even accept donations of restricted stock.

These fund companies, as part of due diligence, determine that the donor's charity is a 501(c)3 public charity. If the charity isn't, grants will not get distributed. The investment companies, like Fidelity, are starting to examine the same issues as nonprofits, like the ratio of fundraising and other administrative expenses to grants or program costs.

Ben Pierce, director of Vanguard's Charitable Endowment Program, says the program has accumulated $250 million in contributions since its inception. He says 85%-90% of contributions to the Endowment Program come from appreciated stocks or mutual funds, while 10% of donations are in cash or wire transfers. With the new wealth created by the boom in dot-coms and some bellwether stocks a couple years back, he says, "I'm surprised we still get 10% in checks." He says a significant number of younger people are now contributing appreciated assets to the fund.

And despite the 2000 year-end market slide, Pierce says, dollar contributions to Vanguard's fund are more than 50% ahead of 1999 tallies. "That's evidence that this type of donor-advised program will weather softer markets as well," he says.

But don't look for Vanguard to start a separate donor-advised fund for advisors. "We do not pay a commission to an advisor to direct clients to us," Pierce says. "We want to run this [Endowment Fund] as a charity, and that isn't a very good way to run a public charity."

He says the real incentive is the advisor providing good advice to clients. "There are ways to help clients' tax situations," he says. "It really is important for financial advisors to understand the consequences of clients holding on to these appreciated assets that have such huge gains in them. Advisors should at least get educated and inform clients about the alternatives. They are becoming more aware, but there is still room for lots of improvement."

You could say that Sam Hull, a planner with Northstar Financial Planning in Bedford, New Hampshire, is a new recruit to the donor-advised funds ranks. "I just became aware of donor-advised funds in the last few months," he says. But he hasn't wasted any time directing his clients to them. Last November, Hull helped eight clients gift appreciated securities to the Vanguard Endowment Fund.

One of the clients was a retired doctor in his mid-80s with a portfolio of highly appreciated blue chip stocks, like Oracle and AT&T. The retired doctor faced an unexpected increase in his 2000 taxable income because in previous years he'd failed to pay the minimum required distribution from his IRA. "Before he became a client, he had made a mistake in calculating his minimum required distribution," Hull says. "He came to me to clarify the mistake and found that he faced the liability [in 2000]. His taxable income went way up and he needed something to offset that." Enter the Vanguard Endowment Fund. Hull says it was a perfect solution. "He could make a substantial contribution to charity [of appreciated stocks], get the charitable deduction, and then at his leisure satisfy his other charitable contributions."

Nancy Frank, of Frank Advisory Services in New York, helped a 45-year-old client who anticipated a large capital gain from a shareholder buyout reap the rewards of a donor-advised account. Instead of accepting the full tender offer, Frank says, the client transferred some of the appreciated securities to a donor-advised account at New York Community Trust. "This way, she receives a tax deduction in the current tax year for the total amount of the securities given, and she doesn't have to designate a specific charitable organization until she is prepared to do so."

T. Rowe Price spokesman John Bielski says the fund company was responding to customers' cries when it launched its program. "Customers were asking for this," he says. The Program for Charitable Giving accepts contributions of cash or publicly traded securities, with a $10,000 minimum investment. Until the donor requests distributions be made to other qualified public charities, contributions may be invested in four investment options comprising T. Rowe Price mutual funds. Bielski says T. Rowe Price has "definite interest in working with advisors," but declined to say whether the investment company would be launching a separate advisor fund.

The Baltimore-based investment company's donor-advised fund also allows donors to invite secondary parties, such as family members, advisors, and business associates, to participate in the account's management and contributions, which is similar to a private foundation. "This feature is especially helpful for families or individuals that are looking to establish a legacy of giving," the investment company says.

Fidelity' Egan says about 75% of the donors to the Charitable Gift Fund say they are giving more to charity because they have a Fidelity account. And during the gift fund's lifetime, Fidelity has raised $1.7 billion for 60 charities nationwide, she says. As for the fees for the charitable gift fund, Egan says that 98.32% of every dollar that is contributed to the fund is available for grant recommendation before any investment performance. This compares with the 40% expense ratio range recommended by the National Society of Fund Raising Executives (NSFRE), Egan points out.

Vaughn Henry, president of Henry & Associates in Springfield, Illinois, is one advisor and fan of donor-advised funds who's all for helping clients achieve a better quality of life through giving. "I like to promote philanthropy because it makes for a better relationship with the customer, and it can be a lot of fun. I say to the client, 'Here's the chance to take control of your life and make the financial planning process more enjoyable.' Usually clients come back and say, 'I feel much better.'" So, no doubt, will you.

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