Over a decade ago I was on a trip to the Greenbrier Resort with colleagues from my previous firm. The head of the Savannah office was at my dinner table and was looking forward to working on a family foundation he had recently taken over as manager. He did not say who he was giving to, but of all the dinners I’ve attended over the years, this one stuck out. He was genuinely looking forward to leaving a legacy.
A bonus was that his foundations made economic sense, as I’ll touch on below.
Regardless of your motivation, if you plan over multiple years and your living expenses are more than met, you should consider a foundation as an option. Foundations are not for everyone – some will prefer charitable trusts, donor-advised funds, and some will prefer toys – but the foundation route ultimately made sense for our family.
Here are some details to consider:
Who would want a foundation?
You will if the following are important to you:
- Charitable giving
- Control over:
- The amounts and recipients of annual gifts,
- Investment decisions, and
- The management and administration of the organization.
- Under certain circumstances allow for you to make a grant to a beneficiary who is a private individual (such as a scholarship), unlike other charitable strategies.
- Leaving a family legacy of giving across generations.
- An income tax deduction. Read more from a previous post: HERE
- Tax-advantaged investment growth.
- Ongoing support for a specific cause or community purpose that is important to you. If your intent is to give, it can make sense to use a tax-advantaged vehicle to grow a corpus of giving.
- You would like to create a role for family members now or in the future, possibly including salary, administration, and responsibilities for researching gift options.
Be prepared with a process for administration – including establishing the foundation with the IRS, plus gifting, accounting, and tax returns. Foundations require a board, as well as recordkeeping if salaries are paid.
How Foundations make economic sense
If you are charitably inclined, you can give out of pocket at random, or you can put the funds into a tax-advantaged construct like a foundation or donor advised fund.
In comparing numbers, assume you have two choices. You can give money away in a lump sum to a foundation, or you can give it away piecemeal over time out of savings.
Either way, assume 4% a year of funds set aside is being gifted (foundations must give 5% and we assume 1% expenses), and both investments otherwise make an 8% market return. The foundation nets 4% after expenses (8% less 4%) and the piecemeal approach nets 6% (8% less 2% for taxes). In this way the piecemeal approach grows faster.
But the ultimate benefit to the giver is greater with a foundation. This is because if the money is going to be given away regardless, the value from the foundation growth and the deduction growth combined wins out.
It looks like this:
Further, the above does not contemplate the potential benefit of a salary to related party employees of a foundation.
These numbers are just an illustration, but the point is that a) the upfront deduction grows in value over time, and b) a foundation’s tax-free growth benefits a donor over time.
Why not just use a donor advised fund (DAF)?
I began with a DAF. My fees were a bit elevated, and the funds go into the fund’s preferred ETFs, neither of which are ideal for me. I do appreciate the administration being taken care of, but I will never be able to involve my family or leave any legacy from the funds.
Donor advised funds also have certain differences, such as only giving to federally-recognized charities. However one benefit is they allow more types of appreciated assets to be valued at market when donated than a foundation would. You can also gift a greater percentage of income to a DAF than you can to a foundation. These are some reasons why some families use both a DAF and foundation depending on their circumstances.
What to do next?
At jhh wealth, we work with clients to structure the right strategy for their charitable giving aspirations. While we don’t provide tax or legal advice, we work alongside your legal and tax advisors to ensure you can implement the right strategy for your goals. We will continue to post different strategies that may be of interest so stay tuned for more information.
Disclaimer
The information presented here is not specific to any individual’s personal circumstances. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. This information may change at any time without notice.