As high-net-worth individuals decide how best to manage, invest, and distribute their wealth, they increasingly wish to include personal philanthropic goals as part of an overall wealth management plan. This provides enterprising financial planners with an opportunity to increase business and add assets under management by adding philanthropic products to their practice.
In 2000, Americans gave more than $203 billion to charity, and giving has grown at a compounded annual rate of 7.9% since 1970. As Americans age, opportunities for charitable giving should continue to grow. The intergenerational transfer of wealth from 1998 to 2052 will total an estimated $41 trillion to $136 trillion, the Social Welfare Research Institute of Boston College estimates. The resulting bequests to charity are estimated at $6 trillion to $24.7 trillion. As giving expands, more advisors are coming to understand that philanthropy is good for their clients and communities, as well as for their own practices. Few conversations will deepen a client relationship as strongly as understanding what drives a person’s philanthropic goals.
Two distinct charitable giving choices that deserve a closer look are donor-advised funds and private foundations. However, while each has benefits, a dangerous blurring of terms needs to be addressed. Donor-advised funds have received much attention over the past few years, especially as they are now among the largest U.S. charities. Unfortunately, some donor-advised funds, including those run by Fidelity Investments and the Heritage Foundation, sometimes refer to their accounts as foundations. Time and again we’ve listened to consumers insist that they have a private foundation, only to peel back the layers and find a donor-advised fund.
In this article, we will clearly define the two, as well as introduce a new model for private foundations that has recently become available. We’ll explore advantages and disadvantages that should be considered when determining their appropriateness for various high-net-worth clients. Understanding each of these planned giving vehicles is important for financial advisors looking to grow a wealth management practice.
Donor-advised funds are popular and effective planned giving vehicles. They have become some of the largest U.S. charities: Fidelity’s Charitable Gift Fund alone has more than $2.6 billion in assets and is second in size only to the Salvation Army. A donor-advised fund is a philanthropic vehicle that is created and maintained within a public charity, such as a community foundation, university, or church. More recently, financial services companies, such as Fidelity, Vanguard, and others, have established their own charitable organizations through which they offer donor-advised funds.
Under current law, donations to a donor-advised fund are treated the same as if they were donations to a public charity. Donors may recommend eligible charities as recipients for grants from the fund and may recommend investment alternatives; however, the fund has the freedom to accept or reject such recommendations.
In 1992, Fidelity launched the first commercial donor-advised fund. Today, this fund is the largest of its kind, with more than 27,000 donors. In donor-advised funds, donors contribute cash or other assets and receive an immediate tax deduction. From this fund, the contributions are forwarded directly to target charities. These funds are a strong option for individuals whose philanthropic ambitions are more modest. Generally, these individuals have fewer funds available to donate, and are less concerned with total control over their donations.
Establishing a Legacy
A private foundation is a special, tax-exempt entity, controlled by an individual or a family. It is organized for charitable, educational, religious, scientific, or literary purposes. To qualify as a foundation and have contributions to it considered tax deductible, the Internal Revenue Service must recognize the foundation as a charitable organization. Foundations provide a flexible, tax-efficient method whereby donors get an immediate tax deduction for charitable donations that are made in the future. Private foundations also enable founders to establish a legacy of giving, plus provide substantial immediate and long-term benefits, including protection from capital gains taxes on assets that have appreciated greatly in value. However, establishing and maintaining a foundation can involve considerable time and expense.
Traditionally, attorneys set up private foundations as individually created entities. Once established, they require legal and accounting assistance to keep them in compliance with state and federal regulations, prepare and process federal and state filings, and process grants made by the foundation. As a result of this built-in cost structure, traditional foundations do not make economic sense unless the initial funding is in the $1 million to $2 million range. However, for foundations of that size and larger, the vehicle itself is an excellent option for those high-net-worth individuals who prefer greater control in how their donations are used and those who seek to create an ongoing legacy. Typically, foundations are best for wealthy individuals who view philanthropy as an important ongoing activity, especially when they desire to include family members in their philanthropy.
For donors who may want to start a foundation with a smaller donation, a new model is standardizing and automating the private foundation. This model offers a significant reduction of the expenses, complications, and administrative burdens often associated with traditional private foundations. As a result, many of the advantages of a donor-advised fund are now available with a private foundation, allowing founders to focus on charitable giving instead of compliance and paperwork. While this new model does not necessarily make a private foundation the best choice, it does make this particular giving vehicle available to a broader audience.
Rather than set up each foundation as a one-off entity (some as trusts and others as corporations), the new model relies on a standardized corporate form, domiciled in a single state, such as Delaware. Because each foundation has a standardized set of bylaws and articles of incorporation, the entire setup process and ongoing administration can be automated to a large degree, without changing the benefits of the vehicle itself. This significantly reduces the time and expense required to deliver a private foundation, and greatly simplifies the ongoing administration, while reducing costs.
The cost saving offers two benefits. It significantly lowers the threshold for initial funding to as low as $100,000, which makes it available as an option to a much larger group of affluent individuals. And it means that more of the dollars donated go to charity: The automated administrative process relieves the founder of the vast majority of compliance oversight amid complex federal and state rules.
The distinction between donor-advised funds and private foundations is never clearer than when it comes to control over asset management and granting. This is an important consideration for advisors. In recent years, there has been a fundamental shift in how people give. Today’s wealthy are less inclined to give an unrestricted, blank gift to a charity. Rather, they are demanding a greater say in how and where donations are used. With private foundations, donors retain control over where their donations go and how they are used. Also, the donor’s financial advisor typically continues to manage the foundation assets. Those choosing to invest in donor- advised funds face a dramatically different situation. Donors can recommend which charitable organizations receive grants, and in the vast majority of cases those wishes are carried out. But ultimate control resides with the fund manager.
Private foundations enable the donor to retain assets in a wide variety of instruments, including stocks, mutual funds, bonds, real estate, and other tangible assets. A donor-advised fund typically obliges the donor to immediately liquidate individual stock holdings and put them into preselected asset management pools based on growth, income, or other goals. This requirement may prevent those with restricted stock from making contributions. Private foundations also provide great flexibility when it comes to choosing grant recipients and may even establish popular granting vehicles such as directed scholarships for specific individuals. Approximately one-third of existing private foundations provide some form of scholarship. Foundations are also able to pay salaries and reimburse expenses required to run the foundation.
Because donor-advised funds are public charities, various state anti-solicitation laws may prohibit the payment of broker commissions by donor-advised funds if the financial advisor is not a registered fundraiser. A private foundation is not a public charity, so brokers and independent financial planners can effectively market it.
Financial planners can also provide management services for foundation assets, for which they may charge applicable management fees. Once assets are contributed to a donor-advised fund, they are irrevocably placed into an investment pool of a public charity, and the financial advisor no longer manages the assets. In some cases, financial advisors may receive a one-time finder’s fee or small ongoing residual payment, but normally this is lower than if they had direct control over the assets.
Philanthropy is a highly personal undertaking that presents significant opportunities for advisors to gain a better understanding and insight into their valuable high-net-worth customers. Donor-advised funds and private foundations are both excellent vehicles, yet it is important to remember each is best suited to a particular type of donor, depending on the donor’s unique circumstances and philanthropic motivation.
|American Assn. of Fundraising Counsel|