From the November 2002 issue of Investment Advisor • Subscribe!

Front Seat Driver

The wealthy are more charitable than ever, and adv

Altruistic charitable giving notwithstanding, philanthropy is pretty much a fourth-quarter phenomenon. Given the outpouring of donations following 9/11 (individuals contributed some $1.25 billion while foundations added another $410 million, according to Frederick, Maryland-based Family Foundation Advisor), it's reasonable to assume that this tax season advisors won't see much client action on the charitable giving front. A year of investor portfolios continuing to head south might also be expected to dim charitable impulses. But advisors expecting a decline in activity might find themselves surprised.

A fair proxy for the level of charitable activity today is the degree of involvement with lawyers. And "trust and estate attorneys have never been busier than over the last year," says Doug Mellinger, president of Foundation Source, a philanthropic services company that helps establish private foundations. He cites as further evidence data showing the continued growth of giving over the past 31 years, both as a percentage of income and in absolute dollars. According to the data, annual giving during this period has doubled each decade and grown through every U.S. recession.

The acceleration of giving can be attributed in large measure, Mellinger says, to aging Baby Boomers devoting more thought to giving as they approach retirement. According to Fidelity Investments, more than $12 trillion is expected to shift from one generation to the next in the next two decades, and possibly $100 trillion in the next quarter-century. If anything, 9/11 has only spurred giving.

Yankelovich Partners estimates that 90% of individuals with net worths exceeding $1 million make annual contributions to charity. Are financial advisors ready for them? Being so makes good sense, since, according to the Spectrem Group in McLean, Virginia, the use of professional advisors jumped from 61% to 74% between 1998 and 2000 for such high-net-worth investors. Fidelity notes that the benefits to advisors of being savvy about charitable giving include deepening the level of intimacy with clients when addressing an issue that involves family values and background; being able to defend your practice against competition by cross-selling your expertise in tax and estate planning issues; and achieving higher retention of clients by offering a range of services to help minimize taxes and attain charitable giving goals.

People give for a number of reasons, from the personal to the practical. While there is a host of charitable giving vehicles for the advisor to employ--direct gifting, donor-advised funds, community and family foundations, and various charitable remainder trusts and gift annuities--the selection of any vehicle must be carefully guided by each client's philanthropic intent. This may seem obvious, but it hasn't prevented some advisors from taking a "one size fits all" approach.

What's the Right Vehicle?

For example, a client who wants some benefit from his charity today is not going to use a donor-advised fund because he won't receive any cash flow; he's better off with a charitable remainder trust or charitable gift annuity. Conversely, a client not seeking cash flow will likely gift outright, opt for a donor-advised fund, or set up a family foundation. "The money is important, but the [client's] soul and spirit are far more important," says Ray Ferrara, an advisor with ProVise Management Group in Clearwater, Florida. "We need to understand their motivations about their wealth, their intent for their money, before we consider how to manage it."

Ferrara says charitable giving will generally first arise while reviewing tax returns. "It may be a discussion we have today and nothing is done for eight to 10 years," he says. "We have the discussion [but that] doesn't mean clients are ready to take the money off their balance sheet and put it on a charity's balance sheet."

While people give for current income tax management and to create a legacy, Ferrara believes that most clients are philanthropic first and tax-sensitive second. Even clients who intended to give stock to fulfill giving pledges and are now trying to restructure those pledges in light of current market conditions are still making every effort to give, he maintains.

It's no coincidence that charities launch fundraising campaigns in September, getting a jump on tax planning and preparation season when investors sit down with advisors and accountants to take gains or losses and discuss charitable giving. Mellinger estimates that 75% of all charitable giving occurs during November and December. The Internal Revenue Service characterizes gifts as complete and irrevocable transfers of money, property, or other assets to IRS-recognized charities (there are more than 700,000 IRS-approved 501(c)3 charities nationwide). The tax benefits to charitable givers are significant, though generally not much use to extremely wealthy givers. In general, the amount that can be deducted is limited to 50% of the giver's adjusted gross income (AGI) in cash or 30% of his AGI in capital assets. The full current market value of appreciated assets can be deducted. It is possible, too, to avoid or reduce taxes on capital gains deriving from the sale of these investments, a very popular incentive.

Anatomy of a Giver

Mellinger defines three distinct giving populations. First is the low- to medium-income group, an enormous chunk of the population. Because they have little savings and don't necessarily own much stock outside their retirement plans, market gyrations have minimal effect upon their giving. They still manage to give modestly, often through direct cash donations. Advisor Tim Hayes, president of Landmark Financial Advisory Services in Rochester, New York, says an argument for giving outright or through a charitable remainder trust can be made to middle-income consumers with relative good overall wealth, even if they have exposure to highly appreciated, low-basis stock and don't want to sell because of the tax consequences. "Of course, the numbers don't work nearly as well if you're talking about $100,000 versus $1 million," he says.

Mellinger characterizes the second group as those with net worths of $500,000 to $5 million. They are "definitely concerned" about the market, and tend to favor charitable instruments such as donor-advised funds. He sees this group as giving somewhat less this year--being "a little bit off"--affected, unlike the first group, by market gyrations. The third group, 700,000 strong, represents the number of U.S. households with net worths greater than $5 million. This group, he says, has been "unbelievably resilient" to market gyrations. This group, the "millionaire next door" type, continues to be very civic-minded and generous.

A Good Foundation

So which charitable giving products work best, and for whom? While there are exceptions to any rule, there is usually no "mixing and matching" of available giving strategies with a single giver, since the advantages of one often offset the other. The vehicle of choice for persons wishing to donate $1 million or more, especially in the case of appreciated property, is the family foundation. Citing the Foundation Center and Giving USA, Fidelity notes that more than 50,000 independent private foundations are responsible for almost 10% of the more than $200 billion Americans donate to U.S.-based charities each year. In 2000, charitable giving assets in independent private foundations grew more than 7% to $409 billion. A family foundation allows its family-member board of directors to take the foundation's investment income and make donations to various charities, either locally or nationally.

The tax advantages, while dollar for dollar, are not as compelling. "If you contribute a million dollars in cash, you're probably going to lose most of that tax deduction," explains Ferrara, "as your income increases--at about $128,000 or $130,000." The most compelling reason for setting up family foundations is that the donors get recognition within their communities. Family foundations don't come cheap, however, nor simple. The legal entity must be set up and tax returns filed each year. The board of directors must meet to decide how best to invest and where to donate the money. Ferrara estimates initial legal and filing fees for a $1 million family foundation to be $5,000 or $6,000. Ongoing accounting work will probably run about $2,500 a year. Then there are money management costs and miscellaneous expenses. All told, the price tag on a $1 million family foundation could run anywhere from $5,000 to $15,000 per year.

For the less wealthy, the community foundation is worth a close look. Bill Welch, president of AM&M Financial Services in Rochester, New York, for example, says some of his clients couldn't be happier with the Rochester Area Community Foundation. Spokeswoman Jennifer Leonard says the foundation is one of 650 nationwide that collectively administer $31 billion in charitable assets (to find a community foundation in your area, visit www. communityfoundationlocator.org). If Welch spots an outsized investment profit during a review of the portfolio of a charitably inclined client, "we say, let's bank it now." What he'll do is sell off part of the profit to bring the portfolio back into balance, and fulfill the client's charitable intent by placing the proceeds into the client's local community foundation charitable checking account--taking the tax deduction that year. Funds can be held in the account until the client is ready to gift the money to a charity during any year.

A variant of the community foundation is the designated fund, which involves the donor's children. Designated funds allow the donor to give away 5% of the account value each year. At the death of the donor (and sometimes the donor's children; this is negotiable) the money becomes part of the foundation's general community fund. In some cases, advisors continue to manage assets earmarked for a community foundation.

Hot Ticket

The hot charitable ticket these days is the donor-advised fund, offered through a host of companies including Thornburg, Fidelity, Vanguard, and T. Rowe Price. These funds accomplish much of what a foundation does without the administrative hassles and expenses. A donor can place $200,000 into a fund account, mull over with the account manager how to invest the assets, and instruct the advisor as to where the donations should be made each year. That's it. Trustee fees for Thornburg Investment Management's National Gift Trust, for example, run 1.25% on the first $100,000, 0.75% on the next $900,000, 0.5% on the next $1.5 million, and 0.25% for everything over $2.5 million.

One of the most popular ways people are donating money today, if they're not giving cash, is through a charitable remainder trust (CRT), which enables donors to give money on a deferred basis. There are several varieties. A charitable remainder annuity trust (CRAT) pays the donor a fixed amount of money each year, at least 5% of the initial investment. A client putting $200,000 into a CRAT would receive at a minimum $10,000 per year, and that payment would be fixed for life, regardless of how the underlying investments fared. Ferrara notes that the annuity payout can be raised to the 7% range without jeopardizing the vehicle's tax deductibility.

Unlike other giving strategies, with a CRT there is no dollar-for-dollar tax deduction. Rather, the deductible amount will equal the calculated remainder that will go to charity at the donor's death. The amount is based on such factors as the donor's age, how much money he takes out, and the expected investment return. A 65-year-old with $200,000 in a CRT might only qualify for a charitable deduction of $80,000, because that figure represents the "remainder" interest that would go to the charity. Ferrara suggests a "bare bones" CRT entry point of $100,000. Associated expenses include tax returns and investment management.

Gauging the Percentage

Cousin to the CRAT is the charitable remainder unitrust. Unlike the former, in which the annual payout is fixed, the latter allows the investor to draw down a certain percentage of the value of the trust each year. "If you invest $200,000 and you're going to draw down, say, 6%, and the $200,000 grows to $250,000, you're going to get 6% of that, or $15,000," explains Ferrara. "Conversely, if it goes down to $150,000, then you draw $9,000. Your payments vary, based on the underlying investments."

Another related variant of CRT is the NIMCRUT, or Net Income With Make-up Charitable Remainder Unitrust. With this vehicle, the donor is entitled to the net income each year generated by the trust.

If for any reason the trust doesn't pay it in a given year, then the trust must make up this shortfall in the future. The NIMCRUT works well for persons who are still working and have maxed out their contributions to their 401(k)s and pension plans, and want another way to create income in retirement. Depending on their tax bracket, they can enjoy a tax deduction for part of it.

In estate planning discussions with charitably inclined clients, Welch recommends the charitable IRA. The client can instruct that all or a portion of the balance in his IRA or 401(k) be given to charity at the death of the second spouse. "Because if you leave the IRA to your kids through your will, they're probably getting 70 cents on the dollar if they're not doing well, because the tax has to be paid on that IRA or 401(k)," Ferrara says. By leaving the IRA or 401(k) to charity, the donor's children don't have to pay taxes on it. As part of an overall estate plan, a charitable IRA "is a way to give more money to charity than you would otherwise."

Other vehicles on the horizon include a measure before the Senate that would allow tax-free rollovers of IRA assets into charitable vehicles as part of the Charity, Aid, Recovery, and Empowerment Act of 2002 (CARE, S 1924); a similar bill (HR 7) has already passed the House. But even without new charitable techniques, the urge to give remains strong despite today's muted economy and markets.

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