Several years ago, one of advisor Doug Neal's clients was facing serious tax consequences on some investments that had increased in value during the time she held them. Since the woman was fond of a niece who was a teacher, the CFP suggested a strategy that would enable her to avoid taxes and give back to her community. With her appreciated assets, he set up a charitable trust that promised her income during her lifetime. After her death, the proceeds from the trust went to her nieces and nephews and, ultimately, to help pay the student loans of teachers at an association of Houston private schools.
"She did it because of the tax benefits and the income stream," says Neal, of Houston-based Neal Financial Group. "But it also made her feel good because she was able to help young teachers."
Wealthy clients with complicated tax situations, philanthropic intentions or both are perfect candidates for charitable giving strategies. "If you're not talking to your clients about their philanthropic goals, you're leaving out one-third to one-half of what you should be doing for them," says Randy Fox, CFP, principal of InKnowVision LLC in Naperville, Illinois. "Just as you would discuss life insurance or any other issue, you need to talk about charitable giving."
In terms of beneficiaries, there are certainly many options. There are over a million charitable organizations in the United States, according to the National Philanthropic Trust, and Americans have been donating to them with gusto in recent years. Charitable giving set a record in 2004, the latest year for which data are available, when it hit nearly $250 billion, according to the Giving USA Foundation.
Philanthropy should be considered in every high-net-worth client's strategic financial planning. However, despite the national trend, even with wealthy clients, advisors themselves may have to introduce the subject. "I've been in this business since 1983 and I have never had anyone once ask about charitable giving," says Neal. "As an advisor, I bring it up for a variety of reasons, but there are four main ways to catch a client's interest."
The tax benefits;
In some cases, the promise of an income stream the client won't outlive;
The legacy they will leave through their gift;
The good their donation can do.
Just as there are many reasons to give, there are many methods for giving.
Foundations and Variations
Many clients may already be writing checks to various charities, but planners can help them understand how to take their philanthropy to a more sophisticated level. "Most people don't know how to go about charitable giving in the right way," Neal points out. For example, simply making an occasional contribution doesn't give the donor any say in how the funds are spent. "Most people like to give something that goes for a specific purpose," he says. "When the advisor looks at a client's assets, they can begin to understand what kind of charitable gift they would want to make and the form it might take."
Two choices include:
Donor Advised Funds (DAFs). These are an increasingly popular option that may be attractive to a wide range of clients. DAFs are sponsored by a variety of organizations, such as community foundations, not-for-profits or financial services firms, as public charities. The client makes an irrevocable contribution to the organization that sponsors the fund, which, based on each sponsor's requirements or the client's situation, might range from a few thousand dollars into the millions. The sponsor oversees investment of the funds, which grow tax free, and their dispersal to charities. Donors can advise on decisions in both areas, but according to IRS rules, "the charity must be free to accept or reject the donor's recommendations." The donor receives an immediate tax deduction of the fair market value of the asset up to 50 percent of adjusted gross income for cash contributions and up to 30 percent of AGI for property.
Related fees are generally low, and although there may be startup and maintenance costs, they usually are minimal and certainly far lower than those typical for a private or family foundation. On a most basic level, DAFs can make life easier for clients who, in the past, made numerous gifts to a variety of charities and had to sort through piles of receipts at tax time. [SENTENCE TKTK ON MINIMUM DAF INVESTMENT]
In evaluating DAFs, advisors should consider the client's goals and tax situation. Like various other options, DAFs make it possible to avoid taxes on highly appreciated assets, receive a tax deduction for the donation, steer clear of estate taxes on the donated assets and satisfy philanthropic intentions. However, DAFs differ from each other and from other charitable giving strategies. For example, some DAFs allow a greater measure of financial advisor involvement than others. In some cases, accounts are managed separately, while in others they are part of an investment pool. DAF sponsors may set restrictions on what charities receive donations based on geographic, religious or other requirements. Some DAFs make it possible for successor generations to become involved in advising on the funds, while others limit involvement to the original donor and perhaps his or her spouse.
Clearly advisors will want to select a DAF that reflects their client's intentions. Under the right circumstances, DAFs "are a great way for the financial advisor to add value to the donor and continue to be involved as the family representative in managing assets," says Philip Tobin, president of the American Endowment Foundation, a major sponsor of DAFs. "Clients can use them no matter what their economic status and stick with them as their situation changes." In addition, Tobin notes, DAFs allow for the kind of anonymity that private foundations--with disclosure requirements--do not.
There are some caveats attached to DAFs, which in recent years have come under increasing scrutiny from the Internal Revenue Service and Congress, scrutiny that may ultimately result in tighter restrictions on this largely unregulated sector. If the donor benefits personally from a donation, that will certainly raise a red flag at the IRS, Tobin notes. In testimony before Congress, IRS Commissioner Mark W. Everson specifically pointed to cases in which a DAF's donations to a college were used to pay tuition for the donor's relative or where donations went to pay for donor "volunteer work" at an NPO. The DAF sponsor's policies should be set up to ensure the programs meet all IRS regulations and expectations. For example, among other steps, Tobin says that his organization asks charities to confirm in writing that the donor will not personally benefit from a donation.
(The abuse of charitable organizations and deductions was one of the items on the IRS "Dirty Dozen" list of tax scams this year, so this area is clearly one the Service is watching. To see the list, go to http://www.irs.gov/charities/index.html .)
Foundations. Compared with DAFs, private foundations offer clients greater control over both investment decisions and grant-making. They allow clients the opportunity to have a specific impact on a community or to make a difference in benefiting a certain cause. One variation is a supporting organization, which is a foundation dedicated to a particular not-for-profit.
However, that power and influence come at a price, basically due to the administration and management required. There's no set threshold for the amount of money necessary to create a foundation, but many advisors counsel against launching one with less than $1 million to $3 million, and some recommend that clients should be ready to give much more before they take this route.
"Foundations are very time consuming to set up," notes Neal. "When you consider the attorney fees, accounting, reporting and other demands, it's simply not worth it for a client giving less than $5 million a year." In any case, advisors may want to recommend that clients begin their philanthropy with a DAF and consider a foundation as their assets and income grow. And of course the foundation must qualify as a charitable organization under Internal Revenue Service regulations and make regular IRS filings and other disclosures.
Contributions to foundations are tax-deductible, but there are some limitations on those tax benefits. Clients can deduct up to 30 percent of their adjusted gross income for cash contributions and up to 20 percent of AGI for appreciated property, both smaller percentages than donations to DAFs receive. Tax regulations require that foundations disperse grants that add up to a minimum of 5 percent of their assets each year. Foundations also face excise taxes on net investment income of up to 2 percent a year. In addition, Tobin notes that tax deductions for non-marketable appreciated assets--such as life insurance policies, real estate and closely held securities--must be made at the donor's cost basis when given to a foundation, but may be taken at fair market value when given to a DAF.
Split Interest and Related Options
Trusts, charitable gift annuities and retained life estates make it possible for clients to contribute to a favored charity and still reap financial benefits beyond tax advantages.
"It's scary to give money away," Neal notes, but the strategies that follow offer clients the chance to enjoy at least some benefit from their assets.
Among the types of irrevocable trusts used for philanthropy are charitable remainder trusts (CRTs) and charitable lead trusts. Each can be set up using cash, but they are particularly attractive for clients who have greatly appreciated assets including, but not limited to, equities, bonds and real estate, because they make it possible to avoid capital gains taxes.
CRTs: Under a CRT, the client or another beneficiary receives income during his or her lifetime or for a term of up to 20 years. When the trust ends, the assets go to the client's chosen charities. As a result, CRTs make it possible to:
Sidestep capital gains taxes on appreciated assets.
Reduce estate taxes for the client's heirs, because the assets in the trust are not included in the client's estate.
Gain a tax deduction on current income when the assets are placed in the trust.
Establish a reliable income stream.
Provide an important gift to charity.
The trusts must meet some IRS requirements. For example, they must pay out at least 5 percent and no more than 50 percent of the net fair market value of their assets each year. When the trust dissolves, the charity must receive at least 10 percent of the value of the gift on the date of contribution.
In a charitable remainder annuity trust (CRAT), the beneficiary receives a fixed percentage of the trust assets' initial value each year, no matter how well the trust investments perform. A trust that started out with $1 million and has an established 5 percent annual payout would pay $50,000 each year to the beneficiary.
Using a charitable remainder unitrust (CRUT), the beneficiary gets a percentage of the annual value of the assets. So, if a strong market causes the trust value to rise to $1.1 million in a given year, a beneficiary entitled to a stipulated 5 percent payout would receive $55,000 that year.
In a net income with makeup charitable remainder trust (NIMCRUT), the beneficiary is supposed to receive a certain percentage of annual trust assets each year, just as in a CRUT. However, if the trust's net income in a given year is below the set percentage, the remainder can be made up in future years when asset performance improves.
Charitable lead trust: In a reversal of the CRT, under this trust the charity receives the income stream for a certain number of years; the client's heirs then get the remainder of the trust assets upon the client's death. The benefits are the same as for CRTs.
Both trusts are well suited to clients who have assets that have grown in value but are not producing much or any income. "Often the client wants to cash out, but may have a capital gains challenge," says Joe Luby, CFP, president of Financial Solutions, Inc., in Henderson, Nev. "For that person, I would recommend a charitable remainder trust. In another situation, they may want to transfer an asset to the next generation without incurring gift taxes. For that client, a charitable lead trust would be best." The advisor should also inquire about the charity's situation. "You have to ask if the NPO needs the money immediately or if it can wait a few years," he says. A charitable lead trust provides income to the not-for-profit immediately and for every year in which the trust is in effect. With a remainder trust, there is no benefit to the charity until the trust dissolves.
In addition, there are variations on these trusts that suit different client situations. For example, with a charitable gift annuity, the client gives cash, securities or another asset to a charity. In return, the charity agrees to pay the client--and perhaps his or her spouse--a certain amount of money for life. The client receives a tax deduction, and benefits from a reliable income stream. In a retained life estate, the client typically might give a home or vacation house to a charity. He or she benefits from the tax deduction on the donation, but retains the right to use the residence throughout his or her lifetime.
Exploring Options
Charitable giving will clearly remain a topic of importance for advisors and their clients. "There is a great deal of wealth being transferred between generations in the next few years," says Luby. As a result, "clients will benefit from these techniques to avoid estate tax. Anyone who deals with high-net-worth clients or wants to should know about these strategies."
Luby recommends that advisors educate themselves about their choices. "Many studies show that philanthropy is one of the prominent issues for high-net-worth folks," he says. "This is one area in the personal financial planning world that does not have a lot of training programs." (For information on charitable designations, see the sidebar on page xx.)
Given an understanding of the choices available, it's important to obtain a sense of the client's intentions, notes Fox. "You need to get to know the client better than just their facts and circumstances. You want to be able to talk to them about their dreams and aspirations. Even though they are incredibly wealthy, a lot have not developed a bigger vision. You need to help them think clearly about what a given charity means to them, how it's affected their life or what they're passionate about. Then develop an idea of how they would like to apply their excess capital."
Anita Dennis is a freelance writer specializing in business and finance.
Choosing Charities
Planners we interviewed say they generally do not get involved in evaluating charities for clients. Certainly, if the donation is to be tax deductible, the organization should meet Internal Revenue Service requirements. Information on exemption requirements and other issues can be found on the IRS Web site at www.irs.gov/charities/churches/index.html.
While many donors will select locally or nationally known charities, some may choose more obscure organizations. To learn more about a charity's reputation, some resources planners or clients can turn to include:
The American Institute of Philanthropy provides ratings of various organizations at www.charitywatch.org.
The BBB Wise Giving Alliance offers evaluations of national charities at www.give.org.
Charity Navigator rates charities based on their evaluation of the NPO's organizational efficiency and capacity at www.charitynavigator.org.
GuideStar provides, among other things, free access to recent Form 990s filed by charitable organizations at www.guidestar.org.
The National Center for Charitable Statistics provides online access to Form 990s and data on various charities at http://nccsdataweb.urban.org/FAQ/index.php?category=31.
Related Designations
The following two credentials are related to charitable giving:
The American College offers the chartered advisor in philanthropy designation. More information can be found at www.theamericancollege.edu/advance/cap/default.asp?section=10.
The American Institute for Philanthropic Studies offers the certified specialist in planned giving designation, administered by California State University Long Beach Foundation. More information is available at www.plannedgivingedu.com/about.htm.
