Strategies for Giving

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.