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Portfolio > Alternative Investments > Private Equity

A Foundation for Success

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The events of September 11 have affected all of us, and one of the effects has been to cause people to rethink their priorities and their goals in life. Perhaps now more than ever, many high-net-worth individuals (HNWs) are seeking ways to enhance the quality of their wealth experience. In addition to focusing on the traditional concerns of risk and return, they are looking for better solutions to the “soft” issues, such as how their resources are put to use in society.

Most HNWs, by definition, have more money than they will ever need. This means that they will ultimately either give it to charity, their heirs, or the government (through taxes). Traditionally, fee-based advisors have addressed these concerns in a context of estate planning. But in addition to being technically complex, estate planning is a topic that very few clients are enthusiastic about. Nobody really wants to think about dying.

But there is another way to address these issues–a way that is satisfying to the client, beneficial to charity, and profitable to the fee-based advisor. The solution? Think philanthropy.

Delving into a client’s philanthropic goals is a perfect opportunity to learn more about a client’s deeply held beliefs. Discussions about philanthropy lead naturally into more profound discussions about social problems the client would like to help solve and about the role of the wealthy in society. These are conversations that most advisors and clients would never get into in any other context, and they can deepen and strengthen the personal bond between advisor and client.

From a financial standpoint, advising a client on philanthropic matters is an excellent opportunity to develop a relationship with client’s kids and grandkids– locking in the family as a client forever.

What’s more, a client who becomes involved with philanthropy will be a more profitable client. When properly used, a private foundation, because of its many tax advantages, will greatly increase the total assets available for the client’s philanthropic activity and for his family as well. This increase in assets translates into increased fees for the fee-based advisor.

Why do HNWs give to charity? There are probably as many reasons as there are donors, but a small number of reasons recur regularly. For the advisor, understanding these common reasons provides a context for raising the issue with clients who might be interested. (Because we believe private foundations offer an attractive combination of control and flexibility, this discussion assumes that a private foundation will be the vehicle proposed.)

#1: To Make the World Better

The desire to make the world a better place, in a big way or a small way, is an essential component of virtually every private philanthropist’s desire. This desire may be highly specific, as for example, the HNW individual who knows he wants to help advance research in the field of gerontology. Or the desire may be generalized and, as yet, unformed.

This latter situation is much more common than you might think. In fact, a large number, perhaps the majority of private foundations, are formed and receive initial funding before the founder has specifically identified what he wants to accomplish. Rather, the founders are committed in a general way to improving the world and expect to grow into the role.

#2: To Minimize Taxes

Few people set up private foundations or make other gifts to charity just for income tax breaks. After all, if someone really places no value on money given to charity or set aside for future charitable use, the 50 cents of taxes they save is less than the dollar it cost. But many HNW people have an unformed feeling that they want to devote part of their wealth to philanthropy. For these people, tax benefits can be the key motivation to get them to act. Once they have acted, and formed a foundation, they then proceed to grow and develop as a philanthropist.

There are three basic tax incentives for HNW people to create their own private foundation. First are the immediate income tax savings. A client can cut his income taxes by up to 30%, every year, simply by funding his private foundation.

A second powerful tax benefit is the income-tax-free growth of assets that occurs inside a foundation. A private foundation is a tax-exempt entity and investment income and capital gains are not subject to income tax.

Third, all contributions to a private foundation are free from gift and estate taxes. Over the course of a generation, this can make a tremendous difference. Avoidance of estate taxes is, for some people, an important trigger to get them to focus on philanthropy.

#3: To Involve Their Children

For many HNW individuals, philanthropy provides a unique opportunity to involve their children and grandchildren, but often, these opportunities must be explained to the client. These opportunities fall into four categories: providing a training ground, teaching values, building relationships, and boosting the kids’ careers.

A recent experience with a client, whom we’ll call Doug, illustrates a common situation. Doug has built a very successful real estate development business. He has seen children of friends make a mess of terrific businesses, and is determined to create the conditions that maximize the chances of success for his own son, Tom.

Doug and his wife have decided to use their foundation as a low-risk training ground for Tom. Doug has dedicated a fraction of his cash flow each year to the foundation. He has made Tom a board member, with the understanding that Tom’s responsibility and authority will increase provided that Tom demonstrates both interest and willingness to learn.

Doug’s main philanthropic interest is education, and that’s where he spends most of his foundation’s money. But Doug and his wife have set aside about 20% of the foundation’s expenditures each year for Tom to use as he sees fit. This gives Tom the chance to operate on his own, without jeopardizing the business or the foundation. It also gives Doug the opportunity to evaluate his son’s performance and growth.

Collaborating on a family foundation can have another benefit for clients’ adult children: helping them meet the right people. There are few more effective methods of networking than the willingness to help people with projects close to their hearts, backed up by the ability to help them finance it. Of course, for this to work, the child must be sincere in his desire to help.

For clients’ children who are in high school, private foundation involvement can provide an edge in college admissions. However, the child’s involvement must go far beyond simply sitting in on meetings or writing a check. With appropriate guidance from parents, the child should identify an area of need, develop a solution, and then apply her own efforts, along with foundation funding, to implement the solution.

#4: To Create a Legacy

Although few people will admit that their motive for philanthropy is to be well remembered, this is nevertheless an important reason. It is most easily discussed with a client by indirect reference–not by talking about their potential legacy, but instead discussing what other people have done and how they’ve been remembered. Rockefeller and Carnegie were once the richest men in the world, yet both are now known best as benefactors of mankind, and each lives on through the foundation that bears his name.

Introducing the benefits of private foundation philanthropy offers a unique opportunity for advisors to strengthen their relationships with clients. A private foundation can greatly increase a HNW individual’s enjoyment of his wealth. And after it has been in place for a number of years, it should also make the whole topic of estate planning more accessible because the client will have gained valuable experience and knowledge that bears directly on some of the most difficult estate planning issues. Finally, because of its direct impact on total client assets, the advisor whose clients create private foundations will find himself managing more money without having to add additional clients.


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