Principal, Briskin Consulting
Charitable organizations are facing the toughest economic times in generations. With the recession causing the largest losses in endowment values in more than a generation and charitable contributions declining for the first time in over 20 years, many institutions are struggling to simply stay afloat.
At the same time, many wealthier donors, who, historically, contribute the largest share of annual contributions, are seeking charitable giving options that deliver a higher level of personal benefits. Not-for-profit organizations and financial advisors face the same challenge: How to encourage giving in an increasing pragmatic environment?
The recession takes its toll
The current recession is unlike anything most people have experienced in their lifetime. According to the 2008 NACUBO-Commonfund Endowment Study Follow-up Survey, the average endowment declined by nearly 23% in 2008. As a result, many organizations, including Harvard University, have laid off hundreds of employees and curtailed programs and services.
At the same time, the recession’s impact on the net worth of donors and their foundations and charitable trusts resulted in a 2% decline in giving from 2007 to 2008, according to Giving USA 2009. This was the first time giving has declined on an annual basis since 1987.
Changing attitudes among wealthier donors
More than half of the charitable donations each year are made by wealthy Americans, and their motivations for giving are largely altruistic. According to the 2008 Bank of America Study of High Net-Worth Philanthropy, giving by wealthy households is driven largely by a desire to give back to their communities and a long-term commitment to supporting specific causes.
Yet, at the same time, the Bank of America study also noted a pragmatic shift in donors’ decisions around charitable giving. In the original 2006 Bank of America Study of High Net-Worth Philanthropy, wealthy households turned primarily to not-for-profit personnel for charitable giving advice, with legal and financial professionals utilized far less often. In the 2008 update, these results are inverted, with donors relying mainly on accountants, attorneys, and financial advisors. And, in nearly all cases, donors initiated the discussion of philanthropy with their advisors, rather than the other way around.
What accounts for this shift? The 2008 Bank of America study suggests that it may be primarily tax-motivated. Avoiding capital gains and estate taxes and maximizing charitable deductions were cited as the primary reasons for establishing charitable giving vehicles. In addition, when asked what kind of giving vehicle they planned to open over the next three years, nearly 21% chose split interest trust and 18% chose charitable gift annuities, compared to 15% for private foundations, and 20% for donor advised funds offered by financial services companies or community foundations.
Of those who either had or were planning to start a split interest trust, 26% were attracted by these vehicles’ ability to deliver “personal benefits or income.” Only 5.4% chose a private foundation for this same benefit. This data indicates that many wealthy Americans wish to integrate private philanthropy into their overall wealth management and estate planning strategies, and are increasingly turning to financial professionals for ideas and solutions.
A ‘personal’ appeal
Given the current economic climate, financial advisors and development officers may need to recognize and respond to this growing demand for tax-advantaged giving vehicles that deliver personal financial benefits. However, traditional planned giving products no longer suit the needs of cash-starved organizations. Remainder vehicles such as charitable gift annuities and charitable remainder unitrusts do not deliver immediate financial benefits to the charity. Most are structured to generate taxable income for current beneficiaries (usually the donor or his or her spouse) over a specific term, at the end of which the remainder interest is distributed to the charity.
For institutions struggling for survival, 10-20 year ‘waiting period’ may be too late. And while charitable lead trusts do provide current income to not-for-profits over a designated period of time, they do not offer the same charitable tax advantages as charitable remainder options.
Is new thinking needed?
It may be time to consider revising the 1969 Charitable Giving Act, which codified the tax treatment of private foundations and charitable trusts, to allow for the creation of innovative new products that encourage giving and while providing charitable tax deductions and tangible personal financial benefits. Clearly, the creation of such products would face an uphill battle in Congress. But what if this option were designed specifically to create a connection between philanthropic education and higher education among the next generation of philanthropists—the children of wealthy Americans?
A possible solution: The Charitable Education Fund
The Charitable Education Fund (CEF for short) would combine the simplified grantmaking benefits of a donor-advised fund, the remainder benefits of a charitable lead trust, and the tax benefits of giving to charity.
A parent would establish a CEF account with a gift of cash, securities, or, potentially, tangible assets such as real estate. For tax purposes, these donations could be tax-deductible, allowing donors deduct a portion of the value of the gift and avoid paying capital gains taxes and estate taxes on the sale of these assets.
Once established, the parent would designate a child to serve as both advisor for and beneficiary of the fund. Fiduciary management of assets in the fund would be handled by a qualified institutional asset management company, bank, or investment advisor.
A hybrid grantmaking vehicle
Like a donor advised fund, a CEF would allow a donor-advisor—in this case the child—to recommend grants to qualified charities which would be distributed upon approval by the CEF’s board of trustees. Unlike a donor advised fund, however, the CEF would have to distribute at a certain percentage of the total value of its assets to charity each year. This combination of simplified grantmaking and mandatory distributions would encourage parents and children to identify and support charities and, more importantly, would prevent the CEF from being used as a tax shelter.
The educational benefit
The mandatory distribution component is essential, because the CEF would offer a significant remainder benefit. When a child matriculated to an institution of higher education, he or she could withdraw all or part of any remaining assets within the fund account to pay qualified tuition, lodging and other educational expenses. Withdrawals would not be subject to federal, state or local state income taxes, giving the CEF similar tax advantages as 529 plans and Coverdell Education Savings Accounts.
Any assets withdrawn from the fund that were not used for qualified education expenses could subject the parent of the child to income taxes and IRS penalties. This would help to protect against potential abuse of the remainder interest. Likewise, should the child not attend college—or choose not to withdraw assets from the account—the CEF would continue to make its annual charitable distributions until either the account was depleted or the advisor closed the account by granting all remaining assets to charity. However, the educational benefits of the fund would be non-transferable. This would prevent a parent from using one CEF to fund the education of other children or grandchildren.
Avoiding loopholes--overcoming obstacles
Any charitable vehicle that offers personal benefits has the potential for abuse, as we’ve seen in recent attempts by the IRS to end the use of supporting organizations as tax shelters and impose stricter penalties on infractions of the rules governing private foundations. Given its combination of personal financial benefits for both parents and children, a CEF would have to be tightly regulated to prevent similar abuse.
For example, the tax deductibility of donations to a CEF might might limited to 20% of adjusted growth income, like a private foundation. A minimum requirement of five years of annual charitable distributions might be established to prevent parents from donating assets a year or less before the child begins to withdraw assets from the account.
Grants from private foundations, charitable trusts and donor advised funds to a CEF would be prohibited. Conversely, a donor-advisor’s grant recommendations would be subject to the same guidelines governing grants from private foundations. Grants to political action committees or lobbyists would be prohibited. Grants to organizations that might result in self-dealing—for example, granting to a private foundation for which the parent serves as a paid director—could be prohibited as well.
Given these and other complexities, creation of the CEF would require significant changes to the 1969 IRS regulations governing private foundations and charitable trusts and the updated charitable provisions of the 2006 Pension Protection Act. Allowing for tax-free educational remainder distributions might also require changes in state tax codes, such as those that were instituted with the creation of state-specific 529 plans. Overcoming these challenges would be difficult, but not impossible, if a consortium of not for profit organizations, financial services companies, and tax specialists pooled their resources, energy and political capital to make it a reality.
Who would benefit most from a CEF?
Given that wealthy families generally can pay for their children’s higher education costs out of pocket, a Charitable Education Fund would probably not hold a great deal of appeal for them, especially as a donor advised fund would offer the same charitable and tax benefits with the added restrictions.
However, for the so-called ‘mass affluent’—households with investable assets between $250,000 to $1,000,000—the benefits of the CEF could hold a great deal of appeal, assuming a CEF account could established with a reasonable minimum donation of $25,000-$50,000 (the cost of a year of tuition at many private and public universities and colleges). For not-for-profit organizations faced with a drop in direct contributions, a CEF could offer a viable new planned giving option for wealthy benefactors. For financial services companies, accountants, attorneys and financial advisors, Charitable Education Fund could provide a powerful tool for helping families meet their financial objectives while encouraging parents and children to collaborate effectively to establish a lifelong commitment to giving.
Copyright 2009 Jeff Briskin. All rights reserved.
