For many of our clients, leaving an enduring legacy is an essential element of their long-term financial goals. But as with ensuring that today’s investments are aligned with tomorrow’s objectives, it is necessary to have a strategic plan of action with respect to giving.
There are multiple philanthropic strategies to consider, each with their own unique set of administrative requirements, time commitments, beneficiary impact, and tax benefits.
And for most of our clients, these sometimes-competing objectives can be achieved with a variety of different options, including Donor-Advised Funds, Charitable Foundations, Charitable Remainder Trusts, and Charitable Lead Trusts. What follows is an exploration of each of these four distinct strategies, along with several considerations for each. This list is not exhaustive, and we invite you to connect with our team for a personalized consultation around your philanthropic objectives.
Donor-Advised Fund (DAF)
A donor-advised fund acts as a charitable investment account held at a brokerage firm or other custodian that offers this service. This type of structure allows you to:
- Make an immediately tax-deductible donation of cash and/or securities
- Grow those assets on a tax-free basis
- Easily make payments to your preferred charities in amounts and at times of your choosing
DAFs are easy to understand and manage, inexpensive to set up and maintain, and provide you with considerable flexibility in carrying out your giving objectives. Because of the low administrative overhead, the DAF is one of the most common giving vehicles that we recommend.
A private charitable foundation is a nonprofit entity you establish that allows you to receive tax benefits, secure your legacy within the community, and pass along philanthropic ideals to the next generation. Charitable foundations can be set up to:
- Enable children and grandchildren to play an active role in giving, by making philanthropy a central part of family discussions
- Provide a public face to your giving initiatives, helping raise awareness for the causes you support while helping to secure your legacy within the community
While these benefits are both potent, charitable foundations can be costly to establish, and many times require the involvement of accountants and lawyers to operate. They also require a significant time commitment from those involved, and the activities (i.e. amounts and recipients of any charitable disbursements) of the foundation are made public through annual tax filings. For these reasons, charitable foundations only make sense for families with a considerable drive for philanthropy who have the time and energy for the administrative overhead that is required.
Charitable Remainder Trust (CRT)
A charitable remainder trust is an irrevocable legal arrangement, formed under applicable state law, in which a trustee holds title to assets on behalf of a beneficiary or beneficiaries.
CRTs are generally structured so that, in exchange for your upfront contribution of assets, the trust pays out periodic taxable income to you and/or others over a predetermined timespan. The assets remaining at the end of the trust term are then distributed to the charities of your choosing.
This strategy enables you to make a donation that is partially tax-deductible, determined based on IRS interest-rate assumptions, with appreciated assets. These assets may subsequently be sold and reinvested by the trust, avoiding the capital gains tax liability that might otherwise arise. Notably, there are two types of CRTs to consider:
- A charitable remainder annuity trust (CRAT) pays out a fixed amount of the value of the trust each year and doesn’t permit additional contributions.
- A charitable remainder unitrust (CRUT) pays out a fixed percentage of the value of the trust each year, recalculated annually, and allows for additional contributions to be made over time.
CRTs typically require a cost-benefit analysis to determine feasibility and can be technically and financially challenging to set up. Additionally, they can be complicated to administer, can’t be changed once they are created, and may potentially leave less (or more) for charitable beneficiaries than otherwise intended.
Charitable Lead Trust (CLT)
A charitable lead trust is an irrevocable legal arrangement, formed under applicable state law, where a trustee holds title to assets on behalf of a beneficiary or beneficiaries.
CLTs are generally structured so that in exchange for your upfront contribution of assets, they make periodic payments to your chosen charities over a predetermined timespan or the passing of beneficiaries. The balance remaining at the end of the term is distributed to your designated beneficiary or beneficiaries, who may potentially benefit from lower estate and gift taxes as well as the income tax deductions associated with the charitable donations.
As with CRTs, CLTs enable you to make a donation that is partially tax-deductible, determined based on IRS interest-rate assumptions, with appreciated assets. These assets may subsequently be sold and reinvested by the trust, avoiding the capital gains tax liability that might otherwise arise.
Like CRTs, CLTs typically require a cost-benefit analysis to ascertain feasibility, can be technically and financially challenging to set up, are complicated to administer, can’t be changed once they are created, and may potentially leave less for charitable beneficiaries than otherwise intended. For these reasons, both Charitable Lead Trusts and Charitable Remainder Trusts require careful consideration prior to implementation.
We hope this article has provided an overview of four key philanthropic strategies that exist and some of the considerations of each. We invite you to connect with our team for a personalized consultation covering your giving goals, objectives, and the strategies which are best suited for your needs.
About the Author: Jeffrey Fosselman, CFP®, CPA/PFS, JD
As Senior Wealth Advisor for Relative Value Partners, Jeff provides comprehensive advisory services in estate planning, income tax planning, cash flows, asset allocation and other financial planning areas. With more than a decade of experience in the industry, Jeff is instrumental in delivering financial planning strategies and counsel to high-net-worth individuals.
Jeff is also an attorney and has provided basic legal services in the areas of business consultation, formation of legal entities and drafting of estate planning documents.
After graduating with a Bachelor of Science from the University of Illinois in 2000, Jeff continued his studies and earned his Juris Doctor from the University of Illinois College of Law in 2003, and a Master of Science in Taxation from DePaul University’s Charles H. Kellstadt Graduate School of Business in 2010. He is also a member of the American Institute of CPAs – Personal Financial Planning Section and holds a CPA license with a Personal Financial Specialist designation. Finally, Jeff also holds the Certified Financial Planner (CFP®) designation.
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Relative Value Partners, LLC which can only be provided through a formal advisory relationship. Clients of the firm who have specific questions should contact their Relative Value Partners counselor. All other inquiries, including a potential advisory relationship with Relative Value Partners, can be directed here.