by Angela B. Rateau, J.D., CFP®, and Robert L. Thalhimer

It is a fact that many wealthy families are philanthropic. Families attend churches, synagogues and mosques, and make financial commitments. They support alma maters, museums and theaters, and make annual and capital campaign gifts. They create private foundations, establish funds at community foundations, and use national gift funds.

But is the financial planning profession giving enough attention to the fact that philanthropy, when planned, can be accomplished in ways that minimize the impact on other financial goals? Consider, for instance, the questionnaires used by financial planners. How many ask the following legacy-indicating questions?

• Do you belong to a church, synagogue or mosque?
• Do you volunteer in your faith community, or for nonprofit or service organizations?
• Do you give annually for capital campaigns or for missions?
• Is there an issue that you care deeply about, where you feel your charitable dollars could make a difference?
• Is there an experience you have enjoyed that you would like to make available for others who are less fortunate?
• Are you actively involved at your alma mater, and do you support it financially?
• Is involving your children in philanthropy a part of your family's values?
• Have you considered a charitable bequest?

If these questions are not asked, we propose that it's a serious oversight, and for the following reason: Clients generally seek out financial planners during the highly productive years of their forties and fifties. Legacy concerns are not usually paramount at this point. More pressing are the demands of children's education, retirement and recreation.

But retirement years are another story. Retired adults have ample time to volunteer, which whets their appetite to become financially involved in charities, and they frequently have substantial discretionary resources. Children by this time are becoming self-sufficient and, if parents are taking advantage of annual exclusions and the unified credit, they are becoming financially independent. As retired adults advance in age and begin to encounter health issues, they are reminded daily of their mortality. Reminiscing becomes a pastime, and legacy gains in importance.

In most cases, the emergence of an individual's "need" for a legacy is predictable from his or her behavior pattern as a younger adult. The client may, for instance, serve on nonprofit boards, volunteer for various causes or support charities financially. Asking the above questions at the beginning of the financial planning process, and continuing to do so as the client ages, will help the planner become attuned to the emergence of legacy as a key planning objective.

Understanding a client's inclination toward legacy brings into play a wealth of planning techniques. The extraordinary income events that most frequently occur during a client's forties, fifties, and sixties—diversifying appreciated assets, exercising stock options or selling a business, for instance—pose excellent opportunities to establish legacies on a tax-favorable basis, while minimizing the negative impact on other aspects of the financial plan. Each extraordinary income event has unique tax considerations, presenting an opportunity to effect a legacy gift.

How best to structure a gift depends on a client's circumstances and his or her philanthropic objective. Let's take a look at two commonly used vehicles—donor advised funds and charitable remainder trusts. Let's also consider the use of life insurance to replace the wealth in the client's estate.

Donor Advised Funds

Donor advised funds are offered primarily by community foundations and national gift funds such as Fidelity, Vanguard, or Schwab. They provide a way for clients to make a tax-deductible gift to a fund within a public charity, while retaining an advisory privilege to recommend grants from the fund to other charitable organizations at a future time.

The primary advantage of a donor advised fund at a community foundation is that community foundations have valuable local knowledge. Donors can meet with staff to learn about community needs, and they have opportunities to engage with other donors who share their interests. Donors may make site visits to community organizations, and they have opportunities to learn from local and non-local experts in various philanthropic fields. The donor's entire family may become involved, and the children may succeed the donor as advisors.

Through this interaction and with good planning, the community foundation can effect the ultimate transformation of the donor advised fund into a legacy endowment after the death of the donor and participating family. Legacy endowments become important community philanthropic assets, which permanently support those charitable organizations and causes that the donor favors, and which may maintain the flexibility to meet emerging community needs.

The donor advised fund is a multi-faceted option. When a gift is made, the donor receives the full value of the tax deduction, providing a useful offset to extraordinary income events. Subsequently, the donor may support his or her charitable interests annually, involving the children as desired. There is generally no set-up cost, and the tax deductibility of a donor advised fund (which is part of a public charity) is greater than for a private foundation. Furthermore, a donor advised fund, unlike a private foundation, requires no annual administrative duties that encumber the normally active lifestyle of wealthy families.

Advantages of Donor Advised Funds Compared with Private Foundations

Consider the following advantages of a donor advised fund versus a private foundation:

• No set-up cost
• No annual filings—a private foundation files IRS Form 990-PF and an annual report to the State Corporation Commission
• No tax payments—a private foundation pays 2 percent excise tax on investment income, or 1 percent if grantmaking exceeds certain levels
• Higher tax deductibility for gifts—up to 50 percent of adjusted gross income for cash gifts versus 30 percent for a gift to a private foundation; up to 30 percent of adjusted gross income for non-cash gifts versus 20 percent for a gift to a private foundation; fair market valuation for appreciated property such as closely held stock versus cost basis valuation for a gift to a private foundation
• Privacy—the donor advised fund name can be anonymous, and its activity is consolidated into the community foundation's IRS Form 990 filing; a private foundation's IRS Form 990-PF is a publicly available document
• Staff support and educational opportunities

Building the Donor Advised Fund into a Legacy

The donor advised fund is a useful vehicle to serve as the beneficiary for other planning techniques. The donor may name his or her donor advised fund to receive the assets of charitable remainder trusts, charitable lead trusts and IRAs. In so doing, the donor creates a legacy endowment of greater size than could have been accomplished during his or her lifetime, which will then serve as a permanent source of support for the donor's philanthropic interests. The language in the donor advised fund agreement tells the community foundation how to administer the fund after the last to die of all advisors.

Charitable Remainder Trusts

A charitable remainder trust provides a way for a client to make a charitable gift that will be received by the charity after the client's death. During the client's lifetime, he or she (or both spouses) receive income at the rate stated in the trust agreement, which is established subject to limitations imposed by the Internal Revenue Service. The client's tax deduction is based on the actuarial value of the gift, which depends on the income beneficiary's life expectancy and the trust's payout rate.

A charitable remainder trust is a good choice when a client wants to make a gift to a legacy fund, to avoid capital gains taxes on an appreciated asset, and to retain a life income interest in the gifted property. It is advisable to meet with the community foundation at the time the charitable remainder trust is formed to execute the legacy fund agreement that will take effect after the client's death, when the trust assets are received. This fund agreement ensures that the client's charitable objectives will be met. It also provides a simple way to make ongoing changes in charitable beneficiaries, which is a normal occurrence as the client serves on various boards and becomes aware of different charitable needs.

There are many variations on the charitable remainder trust. For instance, the payout may be a fixed percentage of the trust's initial value (a charitable remainder annuity trust), or it may vary based on each year's beginning market value (a charitable remainder unitrust). Also, the income beneficiary can be someone other than the client and spouse, such as a child, an elderly family member or another person whom the client wants to support. Your client should consult a legal advisor to structure a trust that best meets his or her needs.

Life Insurance as a Wealth Preservation Technique

Preserving the value of one's estate is sometimes a concern if your client engages in substantial gifting. He or she might consider purchasing life insurance (a quality product purchased from a reputable company), owned by an irrevocable life insurance trust, which would replace the estate value for heirs. Note that an irrevocable trust exists outside the client's estate and avoids estate taxes. Each year, the client makes gifts to the trust to pay the premiums, which are not taxable to the extent they fall within the client's annual exclusion with respect to the trust's beneficiaries. The relative attractiveness of this technique for younger philanthropists drives home the point that planning for philanthropy can be accomplished effectively if the financial planner determines at the beginning of the planning process that a client is likely to become so inclined.

So, what should a financial planner do? Three things: (1) ask the right questions, (2) incorporate discussions about legacy throughout the financial planning process, and (3) get to know the people at your local community foundation.

Learn more at www.communityfoundations.net. 

Angela B. Rateau, J.D., CFP®, is co-president-elect of the Financial Planning Association of Central Virginia.

Robert L. Thalhimer is associate director of the Community Foundation, serving Richmond and Central Virginia. He is a board member of the Financial Planning Association of Central Virginia.