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Cash contributions are an excellent way to ensure that charitable organizations or nonprofits you value have the financial support they need to operate.
The world around us has been and is continuing to be greatly affected by the COVID-19 pandemic. Public charities and nonprofits need your help more than ever to fulfill their missions.
For many high-net-worth families, charitable giving is a collective activity and a central component of their financial plan. Whether you make decisions on your own, or with the involvement of other family members, you must consider the mechanism by which your gift is completed.
Why? Because each giving vehicle carries its own implications for your tax bill.
Rather than direct cash charitable contributions, it may be helpful to establish a private foundation or donor-advised fund.
Both charitable giving vehicles have advantages and disadvantages, so which should you choose?
Let’s explore some details you should review before deciding on the most effective and appropriate giving instrument.
Understand Your Charitable Goals As A Family
Before you decide on your giving strategy, it’s important to establish context for your decision. Knowing your goals and values as a family is the first step. Discuss this together with the family members that will be involved in the process. Specific thoughts to address include the following.
What’s most important to each family member about giving?
Individual perspectives will likely vary. If that is the case, have a deeper conversation to find out why each family member feels the way they do. There may be common themes that underlie each person’s motivations, which can help you all get on the same page and make a coordinated plan.
What causes, missions or values do you want to support?
Start with broad concepts rather than specific nonprofits or organizations. Once you address what the family values most, you can start to narrow down and identify the relevant organizations that may make suitable recipients of your family’s support.
As you discuss these issues together, consider whether you see charitable donations as an important part of your financial and personal life and if it’s something you’d like to see live on for multiple generations. If so, work with your financial advisor to tailor your giving plan to best serve both your family and the charitable cause for the long-term.
Once you have a clearer picture of what you want, you can evaluate your options with more context and clarity.
The Pros and Cons of Establishing a Private Foundation
Family foundations provide a means for families to set up and operate their own charitable giving entities. They are funded and operated solely by the family, who retains complete control over all decisions, including how the assets are invested and any grants the foundations make.
Pros of Private Family Foundations
Private foundations cement a legacy of giving because they can exist as a perpetual entity. The difference they can make extends beyond your lifetime and can involve not just your current family members but also future generations.
You can fund it with nearly any asset that you would otherwise donate to a charity, like appreciated assets, private stock, real estate, or other family-owned assets. If you itemize, you’ll also receive an immediate tax deduction. However, each donors deduction is limited to the following:
Up to 30% of AGI for cash
Up to 20% of AGI for securities (Pro tip, donating securities can help you avoid capital gains tax)
Cons of Private Family Foundations
While private family foundations allow you to retain significant control over the assets and gifting decisions, there are some constraints. One such limitation is that you must give at least 5% of the foundation's assets per year.
Despite the label of “private,” the details about your family foundation are quite public. This includes tax information, donors' names, board members, compensation paid to staff, and investment fees.
Don’t underestimate the amount of work that might be involved in contending with family politics, either.
The Pros and Cons Of Using A Donor-Advised Fund
Donor-advised funds (DAF) are like charitable investment accounts. Similar to a private foundation, you establish a DAF by donating assets that are then set aside to make future gifts. Based on IRS regulations, you receive an immediate charitable tax deduction and can also invest the donations, which will grow tax-free.
Pros of Donor-Advised Funds
Like a family foundation, DAFs provide an excellent means to establish a regular schedule of giving. You can also use a DAF as a strategic giving tool to maximize the deductibility of your gifts through itemized deductions.
For example, assume you want to donate $10,000 per year to a certain organization. That alone won’t allow you to clear the standard deduction, so you don’t really get any tax breaks for it. You could instead donate $30,000 to a DAF, itemize your deduction, and then have the DAF pay $10,000 for each of the next three years.
You can also claim a higher deduction for DAF donations than you can for private family foundations:
Up to 60% of adjusted gross income (AGI) for cash donations
Up to 30% of adjusted gross income (AGI) for securities
Donor Advised Funds don’t have the same public reporting requirements as private foundations, so names and donations can remain confidential.
Cons of Donor-Advised Funds
When you donate to a DAF, you legally give up control, and the charitable gifts are managed by a third party.
DAFs often require a minimum initial contribution to establish, giving you a little less flexibility than you might have with a private foundation. Although, there is no requirement to pay out 5% each year. In addition, account fees like administrative, management, and investment expenses may be high due to a DAF functioning through a third-party organization.
Charitable contributions to a DAF are irrevocable, so you can’t take it back out once you’ve donated.
Which Is Right For You?
The right charitable giving path for you depends on your needs, goals, assets, and legacy plans (like estate planning). Don’t skip the first step outlined above—carefully evaluate your goals before making a decision!
Both your current giving patterns and your expected future giving patterns affect your decision. Work with your financial advisor and tax professional to evaluate how each option could impact your privacy, tax-exempt status, tax returns, taxable income, etc.
If you need help evaluating your options, we would be happy to discuss them with you. Call us to find out how a private foundation or DAF can help you and your family give to nonprofit organizations more effectively.
We also have a comprehensive list of all the most important tax updates and numbers for the 2022 tax year. If you’re wondering where your giving fits in, grab your free copy today.
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Katherine Fonville
Katherine is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors serving clients across the United States. She specializes in helping women aged 50 plus create, implement, and protect a personalized financial plan for retirement.
Katherine is the founder of Covenant Wealth Advisors and resides in Richmond, VA with her family.
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Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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