For many individuals, charitable giving is an ongoing part of life. For others, it’s a future goal tied to financial success and building a legacy. Approaches to giving vary considerably, as they are aligned with personal values, resources and practical issues. However, what all types of philanthropy can benefit from is a structured approach, thorough due diligence and attention to the process of giving, both to capitalize on tax benefits and to assure that the gifts are used effectively. While many articles dwell on tax savings, we thought it would be beneficial to focus here on some ways to get the most impact from your charitable dollars.
Becoming Comfortable With a Charity
Whether for lifetime gifts or bequests at death, via direct or more structured approaches, a key first step in any charitable giving program should be due diligence. Assuming you have a charity in mind, you should look to answer some basic questions: How efficient are its operations? How large a portion of donations go to good works, as opposed to fundraising expenses or overhead? A rule of thumb is that no more than 25% of revenues should be devoted to administration, but this really depends on the type of charity involved. For example, a museum will likely be more costly to run than a soup kitchen. Also, how effective is the charity at investing its own assets? The Wall Street Journal recently reported that the average endowment fund actually underperformed Treasuries from 2009 – 2016.1 Likely it will make you feel better about giving if you know the organization is a successful steward of its assets. Other questions worth addressing concern the makeup of the board, the charity’s overall financial condition, and whether it has any history of controversy. Getting this information should be relatively straightforward, through the use of IRS Form 990, which charities above a certain size must file with the federal government, as well as charitable databases. Faith-based organizations don’t have the same disclosure requirements, but should be willing to provide ample information if asked. If you have more substantial gifts in mind, that should increase your access to organizations for more detailed vetting.
Even if you are comfortable with the results of your due diligence, it may make sense to take things slowly in terms of financial commitments. You might start with smaller regular gifts, for example contributing to a scholarship fund or other need, monitoring the progress of the organization, and assessing how you feel about the experience over time. If interested, you can look to develop more contacts within the organization, and perhaps become involved on a personal level.
Putting Conditions/Limitations on Your Gifts
Assuming you have all the information you need and are comfortable with an organization, you can simply make a general donation, or you may be able to specify how you would like the funds to be used. In some cases, an organization (like a university or medical center) might have multiple gifting options: to the general fund, a building fund, scholarships or other needs.
Let’s assume, however, that you have very specific interests within the umbrella of the group’s mission, which are not covered by the more general categories provided by the fundraising office. What do you do then? Depending on the organization, it may be possible to attach strings to gifts—to direct funds to education of underprivileged youth, to the study of autism or to the construction of low income housing, to name some examples. And although charities typically prefer unconditional gifts, they often enter into giving agreements with some donors outlining the terms. These terms may include the potential use of the funds, performance milestones and, importantly, what happens if the gift becomes irrelevant. For example, if your donation was made for the creation of a computer science chair at your college, but the project was later abandoned, what happens to your donation? Various court cases have dealt with situations like this, and the best way to avoid any misunderstanding or conflict is to be explicit and specific in your donation documents: for example, calling for the redirection of the money to another specific need, to the general fund, or for a return of the assets to you as the donor. Retaining a lawyer to work with the institution on drafting the documentation makes a lot of sense.
Keep in mind that if you get too specific in your conditions, the charity may choose not to accept the gift, whether because of constraints on flexibility, deviation from its core mission, administrative costs or negative social implications. Also, you need to think about whether you want to hamstring the organization if it faces more pressing needs for your assets than the original designation. Finally, conditions can have a tax impact as well. For example, if the gift can revert back to you in some circumstances, it may not be considered an immediate, charitable gift for which an income tax deduction is available.
Resources for Due Diligence
The BBB Wise Giving Alliance3 provides free analysis of national charities, evaluating them against its comprehensive Standards for Charity Accountability.
Charity Navigator4 rates more than 5,000 nonprofits on financial efficiency.
GuideStar5 provides access to charities’ tax filings as well as information on faith-based nonprofits, foundations and others.
Taking More Structured Approaches
In some cases, it may make sense to look beyond direct giving to more structured approaches. For those with substantial assets (upwards of $3 million, $5 million or $10 million, depending on whom you ask), a private foundation can serve as an effective vehicle for philanthropic efforts. In the case of donations to a public charity, you may have limited control over how your money is deployed or managed (aside from the agreements noted above). When you establish a private foundation, you define its strategic mission, decide who will work with you (friends, family, staff) and ultimately dictate (subject to self-dealing rules) how money is distributed. Because the foundation is an ongoing concern, you can parcel out funding gradually to favored charities and potentially influence recipients to be more efficient in their operations or savvy about their investments. Moreover, you can assure that the foundation’s assets are managed effectively, potentially increasing the resources available for your charitable mission. Additionally, if you prefer, you can name the foundation after your family to help assure recognition for your (and their) continued acts of giving.
Keep in mind, however, that creating and maintaining a private foundation is a major undertaking. The initial costs include legal fees to establish the entity—whether as a not-for-profit corporation or a trust—and filings to achieve tax-exempt status. In addition, you should anticipate a variety of administrative requirements over time. Assuming you create a non-operating foundation (which only makes donations, in contrast to an operating foundation that runs its own programs), it must give away at least 5% of its net investment assets every year to qualifying charities. It also must submit an annual public filing to the IRS that includes fiscal data, board member or trustee names and a list of annual grants. Finally, your income tax-deductible donations to the foundation are capped at a lower percentage of annual income than donations to a public charity (although you are able to carry forward the excess to the next five tax years).
A donor-advised fund (DAF) is a simpler, more accessible way to exert some influence over your gifts, albeit with less flexibility than a foundation. In this case, you make an income tax-deductible contribution to the DAF, which creates a managed account on your behalf that is invested based on the options you choose (e.g., conservative, aggressive). You, or those you designate, make grant recommendations to the DAF for distribution to the public charities you wish to support. Once the funds are in place, you can take your time to decide which charities you’d like to support. The catch is that the DAF has final say on whether to honor your grant-making recommendations (though it’s rare for DAFs to reject donor choices). Contribution minimums for DAFs are low (similar to those of many mutual funds), as are the minimum grants to charities. DAFs provide a systematic framework for giving over time, which can allow you to consider carefully your choice of grantees and make changes depending on your evolving interests or the performance of the charities you choose.
Building Charity Into Broader Planning
While this article has focused at a high level on due diligence and structuring your charitable efforts, it’s crucial to keep in mind the financial benefits of a well-constructed approach. For example, with changes to income tax deduction rules and thresholds, it may make sense for some taxpayers to combine multiple years’ gifts into one tax year (something that can be accomplished by donating to a DAF or a private foundation). The use of appreciated public securities as gifts can be a way to avoid taxation on built-in capital gains. Charitable remainder trusts, which we haven’t discussed here, are a time-tested vehicle to provide a lifetime (or term of years) payout stream to the donor (or other beneficiary) and a current income tax deduction on the remainder interest deemed to be earmarked for charity upon the creation and funding of the trust. Charitable lead trusts reverse this equation, with annual payments going to the charity and the remainder interest passing back to the donor or to other beneficiaries upon the termination of the trust.2 In short, the qualitative benefits of philanthropy (social impact, satisfaction and teamwork with family members, to name a few) can be combined with sensible planning techniques to create a winning scenario for you and the charities you seek to benefit.
A Foundation for Charitable Giving
Philanthropy can take multiple forms, and ideally will be designed to tightly fit the donor’s personal situation and charitable goals. Although approaches vary, a private foundation can be a particularly effective way to structure a long-term giving program. Here is a hypothetical example of how one might work:
Tom is 70, retired and unmarried, with assets sufficient for his personal needs. He has several causes that he feels passionate about and wants to support after death: to help runaways get a new start, enhance inner city school education and encourage the inclusion of the developmentally disabled in the workforce. In all cases, he wants to achieve tangible and repeatable results, as well as effective administration of his gifts.
Over multiple conversations with his wealth advisor, they explore the scope of his interests and the resources he wants to devote to them. Based on their discussions, the wealth advisor arranges a meeting with the client, his estate planning attorney and a trust company firm (such as the Neuberger Berman Trust Company) to consider possible structures for Tom’s charitable efforts. Tom decides to create a private foundation, to take effect at his death, and avail him of the estate tax deduction for this gift to charity. The estate planning attorney drafts the documents in consultation with the trust company. Eventually, key participants in running the foundation (structured as a trust) will include the wealth advisor as coordinator, the trust company as trustee and Tom’s family members and friends, who will serve as members of the distribution committee for potential grants.
Because portfolio management can also be the responsibility of the trust company as discretionary trustee, Tom can worry less about the investment acumen of the ultimate recipients. With a committee devoted to performing due diligence on charitable recipients and monitoring their progress, the foundation will be able to encourage best practices and have the flexibility to change course should any of the charities prove ineffective or subject to “mission drift.” As mandated by tax law, the foundation (a non-operating foundation) will distribute annually at least 5% of its net investment assets to deserving nonprofits.
Note that if Tom felt he would definitely not need the funds in future years, he might choose to establish and fund the private foundation currently. Then, he would be able to take an immediate income tax deduction upon the funding, and participate himself in the work of the foundation. However, with the testamentary transfer, his initial legwork in identifying potential recipients when thinking through the mission statement for his future foundation can provide valuable insights when the charitable program eventually begins upon his death.