From the November 2003 issue of Investment Advisor • Subscribe!

Pathfinder

When you understand your clients, and their charitable giving options, you can make a difference in their lives and our world

Millard Fuller thought he'd given his young wife Linda everything she could possibly want. With a posh home in a tony neighborhood (and a maid to clean it), a lakefront vacation home, a horse farm, two power boats, and a million-dollar bank account, Fuller figured he'd hand-delivered her the American Dream.

Except that Linda didn't think things were dreamy at all. She never saw her workaholic husband, and she'd never been particularly interested in the trappings of his success in the first place. She wanted a simpler, more meaningful kind of life, she told him ... and if she didn't get it, she was leaving.

The last part of that conversation, as Fuller recounts it in his book A Simple, Decent Place to Live, went something like this: "So, you want me to give away the humongous house, and the cool boats, and the horses, and the land, and our million bucks, so we can do something ... 'meaningful'?"

And Linda said, "Yup."

Incredibly, that's exactly what they did. They gave to charity everything but a small sum to live on, and founded an organization whose goal was nothing less than eliminating substandard housing from the face of the planet. Their friends thought they were crazy. But in the subsequent 25 years, their nutty little venture, now known as Habitat for Humanity International, has built more than 150,000 simple, decent, affordable homes for low-income families, and those homes provide shelter for more than half a million people around the world.

If that isn't a life with meaning, it's hard to imagine what is. But your clients don't have to take a leap as dramatic as the Fullers' to gain the satisfaction of sharing their wealth with those in need. Moreover, you can help them do it. The Fullers' crisis of purpose, while more dramatic than most, is actually typical of many well-to-do individuals who, after years of struggling up the ladder of professional and financial success, reach the top only to find themselves scratching their heads and muttering, "Okay, now what?" The answer to "now what?" can come from within, as it did for Linda Fuller, but in many cases, it can also come from without. Indeed, according to a 2001 study by New York-based GivingCapital, Inc., more than 80% of individuals who made major charitable gifts were introduced to the idea by their financial advisors; less than 2% came up with the idea on their own, while 11.5% got the idea from the charity and 5.4% were encouraged to do so by a family or friend.

Helping clients fulfill their charitable dreams has always had benefits for both client and advisor: The client gets to help causes she believes in while also gaining tax advantages; the advisor gets to help society by facilitating a gift while also deepening his relationship with the client. Yet charitable giving advice has also been seen as a Pyrrhic victory for advisors, since the gifted assets are generally moved out of the advisor's reach, and the fees on those assets no longer end up in the advisor's pocket.

The good news for advisors is that all that's changing, says Eileen Heisman, president of the National Philanthropic Trust, a donor-advised fund based in Jenkintown, Pennsylvania. "There was a time when advisors rarely got paid for recommending or managing charitable vehicles," she says, "but it's emerging as a much more accepted practice." While some advisors still aren't familiar with the workings of traditional donor-advised funds, says Johnne Syverson, a planner with Syverson, Strege, Sandager & Company in Des Moines, even fewer realize that they can get paid for managing the assets inside the vehicle, and at least in some cases, can stuff it full of all kinds of securities, not just mutual funds. "When I mentioned donor-advised funds to a group of advisors two weeks ago, everybody said, 'Well, jeez, donor-advised funds are no good, because I can't manage the money inside them!'" says Syverson, who is also president of the National Association of Philanthropic Planners (www.napp.net). "And I said, 'What on earth are you talking about? Of course you can manage the money! You just have to find the right fund.'"

But let's back up a second. In a traditional (non-advisor-managed) donor-advised fund (DAF) such as the Fidelity Charitable Gift fund (www.charitablegift.org) or the funds offered by many community foundations, the donor/client grants assets to a fund, gains an immediate charitable tax deduction on those assets, and then at her leisure can instruct ("advise") the fund to dole out grants on her behalf to the charities of her choice. The assets inside such funds are typically invested in several investment pools; for instance, the Vanguard donor-advised fund, known as the Vanguard Charitable Endowment Program (www.vanguardcharitable.org), offers a gift preservation pool (invested in money market and short-term bonds), a moderate growth pool (60% equities/40% bonds), a growth pool (80% equities/20% bonds), a total equity pool, and a socially responsible pool. (The funds in each pool except the last one are Vanguard funds; the SRI pool comprises funds from the Calvert Group [www.calvertfunds.com].) Donor-advised funds of all stripes generally charge two sets of fees to the donor: an investment management fee (in this case, the fund pool's expense ratio), plus a charitable administration fee, which covers paperwork, due diligence on the charitable recipient to ensure that it is a 501(c)3 in good standing with the IRS, and cutting checks to the charities.

Unlike private foundations, which typically cost a minimum of $4,000 to set up, there are typically no initial setup fees for donor-advised fund accounts. Donors can also place "standing orders" for annual gifts, says Ben Pierce, executive director of the Vanguard Charitable Endowment Program. "'Standing grants' are a common practice in our program," he says. "We'll still research the charity every year, and check back with the donor every three years to make sure they want to continue the grant." In addition, clients can simplify their giving through a donor-advised fund. "One of the beauties of the donor-advised fund is that if you want to give $10,000 a year in $1,000 chunks, instead of trying to figure out how to wire money to 10 different charities' brokerage accounts, you can give that single block of stock to the DAF, and they'll liquidate the stock and send the grants out for you," says Heisman.

Traditional donor-advised funds can be perfectly appropriate for many clients and have proven popular, as evidenced by the $5.8 billion, $750 million, and $380 million that have been contributed to the traditional donor-advised funds at Fidelity, Schwab (www.schwabcharitable.org), and Vanguard, respectively, since their inception. What's more, the Vanguard product is about as inexpensive as they come: in a field sporting 1% charitable administration fees and 1% investment fees, Vanguard offers a 57 basis-point administrative fee and fund pool expense fees of approximately 25 basis points.

A Choice, Not an Echo

But "donors don't like investment pools, they like choices," says Philip Tobin, founder and president of a Hudson, Ohio-based donor-advised fund called the American Endowment Foundation, or AEF (www.aefonline.org). Advisors like choices, too, he says: the ability to manage the client's charitable assets inside a donor-advised fund and earn fees on those assets, the option to place a wide variety of securities in the account, and the freedom to open such an account for clients with portfolios of all sizes. Tobin's donor-advised fund, which he and his son founded in 1993, offers all of those features. With $45 million in assets and 320 accounts, "we're a well-kept secret," says Tobin. ("We may have to kill you for knowing this information," he says with a laugh.) But advisor Syverson swears by the American Endowment Foundation's services, which he has used for 10 years. "They're like a national community foundation, and they do a wonderful job," he says. The minimum contribution is $10,000, and the minimum grant size is $250. Charitable administration fees start at 1% on the first $500,000, down to 0.25% on anything over $2.5 million. Investment management fees, which go directly to the client's advisor, are determined by the types of investments chosen by the advisor, and must be approved by AEF. ("You can't come in here with 400 basis points on a wrap account or anything like that," says Tobin.)

Tobin hatched the idea for AEF while working at the Cleveland Foundation as the chief financial officer. "I noticed that once I told an advisor that he couldn't manage the client's assets or custody those assets where he pleased, I'd never see him again," says Tobin. So he decided to launch a donor-advised fund that would cater to all the advisors who had once turned on their heels. "We work exclusively through financial advisors, the assets can be held at any financial institution, and the exact relationship that the advisor had with the client before coming to us is the one we want them to have after the gift is made," he says. Interestingly, Tobin has refused requests to offer a private-label version of his fund through other financial institutions. "We decided to make [our organization] fiercely independent, because we don't want advisors to be concerned that we're going to take these dollars away from them by recommending the services of another institution," he says. "It has probably hurt our growth, but it's also what advisors like, because they know we're not a threat to them."

Another appealing player in the field of advisor-managed donor-advised funds is Indianapolis-based Renaissance, Inc. (www.reninc.com), says Syverson. Renaissance also offers flexibility regarding who can manage the assets and what they can put in the fund, a fee schedule similar to AEF's, and an even lower initial investment ($5,000). "The clients appreciate the fact that we can manage their investments even after they've been gifted to the DAF, because they have a comfort level with the way we manage their other investments," says Syverson.

Also in the field is the aforementioned National Philanthropic Trust (www.nptrust.org), and the industry's 800-pound gorilla, Schwab, which joined the crowd in September of this year. But these programs have some additional restrictions. The National Philanthropic Trust, for instance, allows advisors to manage the assets inside donor accounts of $1 million or more, but requires smaller accounts to be managed by pre-approved managers. Fans of AEF's independent approach should also note that National Philanthropic Trust's distribution is split 50-50 between retail investors and advisors, who access the program through corporate private-label agreements. Corporate partners include Legg Mason, JP Morgan Chase, Morgan Stanley, American Express, Bank of America, Franklin Templeton, and Fiduciary Trust.

And while Schwab's new Charitable Asset Management program, launched in September 2003, allows advisors to place a wide variety of investments in clients' donor-advised fund accounts, advisors can only manage accounts of $500,000 or more, and the assets must be custodied at Schwab, says Kim Wright-Violich, president of the Schwab Fund for Charitable Giving.

Building a Foundation

As donor-advised funds continue to reinvent themselves and garner ever-increasing attention, private foundations also continue to attract a crowd. Assets at Foundation Source, a Norwalk, Connecticut-based provider of turnkey foundation services, jumped from $26 million to $200 million in 2003 alone, and vice chairman and founder Doug Mellinger predicts that the combined forces of new advisor agreements, new corporate contracts, and additional funding of existing foundations will push the company's assets past $1 billion by the end of next year. Interest in foundations has yielded private-label agreements between Foundation Source and a slew of major players, including TD Waterhouse, Bear Stearns, Datalynx, National Advisors Trust, U.S. Financial, EnvestNet, and Bank One.

Fidelity, too, has jumped on the foundations bandwagon, launching Fidelity Private Foundation Services in June of this year, although Fidelity's Andrew Tapp? declined to say how much money is currently managed within the program.

So how do you help a client determine whether to choose a donor-advised fund or a private foundation?

The simplest way to describe the difference between a private foundation and a donor-advised fund, says Heisman, is that the former "is starting your very own charitable bank, and the latter is like opening an account at somebody else's charitable bank; [the latter] is a lot simpler, and somebody else handles all of the back-office work." Ironically, by lowering the barriers to entry, streamlining the set-up process, and centralizing the back-office functions for many foundations, the new turnkey foundation services are, in some ways, starting to resemble donor-advised funds. "I have to laugh a little bit, because they're making the private foundation feel like a donor-advised fund," says Heisman. "They're trying to make the private foundation as easy as a DAF, and I feel like saying, 'Well, if you're going to do that, why don't you just do a DAF?' But hey, to each his own."

Foundation Source's Mellinger is perhaps overstating the case when he dismisses the donor-advised fund as "a pass-through tax simplification product" for "the lower end of the high-net-worth market." But it is true that private foundations offer certain advantages that donor-advised funds can't. For instance, private foundations can make grants to individuals, thus enabling the donor to fund scholarships, assist an individual facing financial hardship, or patronize a favorite artist, says Mellinger. Foundations are also better equipped to handle international giving, and are more consistently suited to transfer the control of charitable dollars down through multiple generations.

"With some donor-advised funds at certain community foundations, if you were my daughter, I as a donor-advisor could pass the money to you [as the next donor-advisor], but you couldn't pass [the control of the funds] on to your kids," says Heisman, so it's important to check. Private foundations can also employ staff members, and start their own community projects from scratch (rather than be limited to making grants to a 501(c)3 organization). And don't forget the ego appeal for Mr. Jones to be able to jauntily mention "the Jones Family Foundation" to his pals on the golf course.

But come on, says Syverson: How many people are really planning on launching a community initiative with a full-time staff? "Most people will use their foundation as a non-operating, grant-making foundation, and that looks and smells like a donor-advised fund to me," he says.

Besides, says Pierce, what's the point of facing the extra expense ($4,000 or more for initial setup of a foundation, versus $0 for a DAF), special tax filings (the highly un-fun Form 990 PF), distribution requirements (private foundations have to distribute 5% of their assets annually or face excise taxes), and less attractive tax deductions when you can get many of the same benefits without them through a donor-advised fund? "You can name your donor-advised fund whatever you want--the Fishes and Loaves Fund, the Bill and Melinda Gates Fund, the Chocolate Cake Fund--and after a while, you begin to feel like Bill and Melinda Gates, who have the largest private foundation in the country," says Vanguard's Pierce. "It feels like an investment, because you can choose where the money is invested, even though it's no longer your money. And it's simple and efficient."

Although some industry leaders suggest that the decision between a DAF and a foundation should be motivated by the amount of client assets involved, Heisman disagrees. "People used to say that it was a threshold issue, but I don't think it's that so much as a donor control issue, and their interest in or disgust for the administration of it," she says. "Some people don't mind the administrative work; other people think it's a big pain in the neck."

Foundation advocates are accurate in pointing out that the money in a donor-advised fund isn't really controlled by the individual anymore; the donor-advised fund, which is actually a charity itself, has final say in what grants get made, and the donor is simply "advising" the fund about what to grant to whom. But it's something of a moot point, since most of the time, the donor-advised fund does exactly what the donor advises--and when it doesn't, the turnkey foundation services wouldn't have done so, either. "Whether the charity is on the right or the left of the charitable spectrum doesn't matter to us; what matters is whether that charity is still in good standing with the IRS," says Vanguard's Pierce. "We don't make any political judgments." All of the donor-advised fund and turnkey foundation providers echoed Pierce's remarks, noting that the other major reasons a grant request would be turned down is if the charity were on a terrorism watch list, or the client stood to receive personal gain from the grant. "Let's say your grant recommendation is for $32,450 to Trinity College in Hartford, Connecticut, which just so happens to be the yearly tuition at Trinity--we're going to look into that," says Pierce. "We actually had someone try this about four years ago, and we said no."

Charitably minded clients should also realize that there's a privacy difference between private foundations and donor-advised funds. An IRS ruling in the spring of 2000 required private foundations to make their tax returns public, thus revealing officers' salaries, plus the names of charitable recipients and how much grant money they received, says Schwab's Wright-Violich. As a result, several Web sites now publish this information on all 65,000 of the private foundations in the nation. "There's nothing private about a private foundation," says AEF's Tobin. What's more, "the state attorneys general and the IRS have been auditing quite a few private foundations because of abuses in the past, and we've got [State Attorney General] Eliot Spitzer in New York saying that he wants the IRS to ban all private foundations with less than $20 million," says Wright-Violich. "It all conspires to create an environment where we needed to provide a vehicle that had some of the advantages of a private foundation but addressed the challenges of that vehicle as well."

Mix and Match

But maybe your client doesn't even need to choose. According to Heisman, one of the most interesting recent philanthropic trends is the desire to have more than one charitable giving vehicle. "I have a lot of donors who have a private foundation and a DAF, and I have one donor who has a foundation and three or four DAFs," she says. "They might have one at a religious foundation, and another at a national community foundation; they might advise one with their kids, and advise another by themselves. It's not like you can only pick one vehicle and can't do anything else; it's like recreation--you might play tennis, but you also ski and swim."

Clients can tie different vehicles together, too, and the combinations are endless. "You can link them up so that the residual charity of the charitable remainder trust is actually a donor-advised fund," says Heisman. "That way you can have income in your lifetime [from the CRT] and then you can leave your kids a pot of money to make grants from after your death."

Or, you can link a charitable lead trust and a family foundation. A Syverson client with net worth of $10 million decided that his children should have $3 million in inheritance and at his death, any assets above $3 million should go into to a testamentary charitable lead trust--that's the one where the apples go to charity every year, and the tree eventually goes to a chosen beneficiary; in this case, the children. The term and payout rate of the trust would be chosen by the client's executor based on the estate tax laws in force at the time of his death such that no estate tax would be paid, and the charitable beneficiary of the CLT's "apples" would be the family foundation. "It's a plan-as-you-go, zero-estate-tax planning method, and the guy was just ecstatic about it," says Syverson. "If he doesn't come back from his European vacation, he knows that his kids will get $3 million, and their family foundation will get the income off a $7 million charitable lead trust for maybe 20 years or so, and at the end of the period, the children will get whatever assets remain. It's just phenomenal, what you can do when you integrate various charitable planning tools into the traditional estate planning process."

The world of charitable giving is sometimes a complicated one, but the rewards can be great for both you and your client. The list of worthwhile causes is endless, and as an advisor, you're uniquely positioned to help make sure your clients' charitable gifts are as effective as possible in making the world a better place. And that's meaningful work by anyone's standards--even Millard and Linda Fuller's.

Reprints Discuss this story
This is where the comments go.