A Primer on Philanthropic Vehicles

Reviewed by Andy SmithFact checked by Suzanne Kvilhaug

Philanthropy and charitable giving are important to many clients, but are not top of mind for many advisors. Helping clients meet their charitable goals is not only the right thing, but helping them do it the right way can provide them with tax and other savings and help you build a niche as an advisor.

There are many ways to be financially charitable, but each way comes with its own challenges. While your client might just be focused on the safe delivery of their contribution, you may have to monitor and manage various aspects of these gifts to ensure their success.

The advisors we spoke with said there’s often a give-and-take between the efficiency of the gift and the tax advantages. David Flores Wilson, a certified financial planner at Sincerus Advisory in New York City, said, “The tendency is to put the focus on which vehicle one should use to give or how much one can save on taxes. To magnify the impact of charitable giving, we recommend first focusing on refining one’s philanthropic purpose and the most effective strategy on executing their purpose.”

Others emphasized how these discussions are too often limited to high-net-worth individuals. “The common misconception that many people have about philanthropic vehicles is that they are too expensive, too much of a hassle, or just for the very wealthy,” Mike Hunsberger, a financial advisor with Next Mission Financial Planning, which focuses on military personnel and veterans. “I find that I have to educate clients that there are solutions even for those giving more modest amounts that … will actually let them give more money to their causes because of the ability to save on taxes.”

Below, we provide tips on what you need to consider as you guide your clients through their philanthropic giving.

Key Takeaways

• Charitable giving is an excellent way for individuals to help good causes while also reducing their taxes.
• Your clients have a variety of assets they can contribute, with cash being the most common and easiest to transmit.
• Other common sources of philanthropic contributions include appreciated securities or real property.
• Your clients have many other philanthropic vehicles they can use.
• While direct donations are the easiest vehicle, others, like donor-advised funds (DAFs) or trusts, lower one’s tax exposure while providing the donor with other benefits.

Types of Gifts

While many charitable vehicles and techniques can be incorporated into your client’s estate plan, many clients focus on contributing while alive. Just like your client might already have a diverse portfolio full of various types of assets, your client might be able to use different kinds of giving.

“In a well-constructed wealth management plan, everything is balanced,” said Mitchell Krauss, a financial advisor with Capital Intelligence Associates in Santa Monica, California. “It’s only after understanding the big picture that one can balance one’s needs with one’s goals of caring for the people and causes that are most dear to them.”

Flores-Wilson stressed that, when helping choose a philanthropic vehicle, you’ll need to review “the upfront and ongoing costs, the level of control over the assets, tax deduction limitations, donor privacy, the types of assets that can be contributed, administrative requirements, and the minimum amount needed to establish the vehicle.” He said assessing each of these is important to ensure the charitable method aligns with your client’s goals and finances.

Cash

Cash is the most basic donation, and the one most clients are familiar with. Giving in cash often entails writing a check to a charity or other tax-qualified organization. 

Pros

• Cash can immediately be used by the beneficiary of the gift.

• Cash is straightforward to account for as a gift; there is no valuation or liquidation that must occur.

• Cash donations are often eligible for itemized deductions on the donor’s federal income tax return.

Cons

• Unless your client was already holding the cash, there will likely be taxable transactions that occur to liquidate other holdings into cash.

• Cash can be used by the beneficiary in any way.

• As opposed to donated tangible property that can only be used in a specific manner, there is less guarantee the cash will be spent as intended.

Appreciated Securities

Gifts of appreciated shares of individual stocks, mutual, exchange-traded, or closed-end funds, can be made to qualified organizations. After contacting the organization directly to confirm they can handle such gifts, you can help your client transfer the shares from their account to the organization’s brokerage account.

This can be a great solution for clients with highly appreciated, low-basis holdings. Your client receives the tax benefit of charitable contributions based on the market value of the shares when the contribution is made. They also won’t be subject to the capital gains they would incur if the security was sold outright. This can be a sizable amount for securities held for years on an extremely low cost basis.

Pros

• Your client receives a more favorable tax treatment than if they sold the stock and donated cash.

• Since the process is managed by brokerage firms, there is less risk of your donation getting lost in the process (as opposed to a paper check).

• Your client may have more money in their investment portfolio than sitting in their bank as cash.

Cons

• The recipient must be equipped with a brokerage account. Some smaller nonprofits don’t accept stocks.

• Donating stock can be complicated; instead of writing a check, two or more brokerage firms must be involved.

• Accounting for the stock donation is slightly more complex for the beneficiary, especially if the price of the security changes after the gift is received and before it’s sold.

• Stock donations must come from eligible brokerage accounts; for example, the security can’t be transferred from an individual retirement account (IRA).

Gifts of Other Property or Assets

Clients might also want to give assets that aren’t securities. For real estate, stock in a privately held business, art, or collectibles, the asset’s value at the time of the gift is deductible, as with publicly traded securities. Also, like publicly traded securities, the client will not be subject to capital gains taxes due on the unrealized appreciation of these assets.

However, the charity your client chooses needs to be able to accept these types of assets as gifts. It’s best to work with your client to contact the organization and confirm this. Generally, you will need a third party to first appraise the asset so its value is documented.

Pros

• Your client receives favorable tax treatment over selling the stock and donating the cash.

• Your client may have more money tied into real property than sitting in their bank as cash.

• Real property can be dedicated to a specific use. For example, your client may want an art piece to be hung at a nonprofit’s office. Your client may receive greater intrinsic value from the gift of real property.

Cons

• Property typically must be valued in advance of the gift so you know its market value.

• Some types of property may not have liquid markets. It may take the beneficiary some time to convert the real property into cash.

• The beneficiary will need to safeguard the asset until liquidation; there is an increased risk of theft, damage, or loss of value before it’s sold.

How to Give

Knowing what to give is the first step. “It’s helpful to narrow which values guide one’s giving (equity, empowerment, etc), determine which causes one cares about most (education, health, environment, etc), discern which organizations express that purpose in the most impactful way, then determine which vehicles are most appropriate,” Flores Wilson told us. “This will help move from reactive giving to proactive giving.” Once you’ve done that, you can then look at the most tax-favorable way to do so.

Giving Directly to the Organization

Direct donations are the most common form of giving. When a client gives cash, securities, or other assets directly to the organization, the latter then takes the cash (or the equivalent from the sale of assets or securities) and puts this money to work in line with its mission.

The Gender of Donors

Two-thirds of U.S. and Canadian donors are female, 32% are male, and 1% identify as nonbinary.

Donor-Advised Funds

Another popular way to give is through donor-advised funds (DAFs), which are philanthropic funds established as public charities. Many large custodian firms, such as Charles Schwab and Fidelity, offer versions of these funds that take donor gifts and invest the money on donors’ behalf. Depending upon the fund, donors can choose from investment options offered by the fund or have the money invested in a fashion suggested by an advisor.

“I think most donors don’t know that some [DAFs] provide significant resources to donors that can help their philanthropic journey,” Flores Wilson said. “DAFs can point donors in the right direction when it comes to narrowing down a suitable charity” where the donor can direct their funds. In addition, he said, “DAFs can connect donors with other donors with similar interests to facilitate conversations and foster community around particular causes.”

Donors usually select the recipients of their donations, and most charitable organizations are eligible, though they must meet Internal Revenue Service requirements. While not as direct as a cash gift, DAFs allow donors to give several years’ worth of donations at a time, receiving credit for the gift for tax purposes in the year of the donation and spreading them over several years.

The receiving organization benefits from the appreciation in the investment account. This allows clients to “bunch” deductions into specific years to ensure they are able to itemize deductions in advance of changes in the tax law. In some cases, DAFs can also accept illiquid assets, providing a source of liquidity for donors as well.

Private Foundations

A foundation is a wealth fund established for a charitable purpose. Well-known foundations are public entities that receive financial support from many donors. Alternatively, a private foundation is a distinct type of philanthropic vehicle with a very limited number of funding sources. Often, a private foundation will only have one individual, family, or corporation responsible for all the giving.

Private foundations are tax-exempt 501(c)3 organizations. With a private foundation, your client controls the mission, who sits on the board, where and how funds are invested, and which charities are supported. In addition, private foundations can be created to operate perpetually after the client dies.

Charitable Trusts

Charitable trusts can also have tax incentives and reduce the amount of assets that an estate oversees. They eliminate probate for your beneficiaries, and these vehicles can create income streams for your client or their future beneficiaries.

There are two main types of charitable trusts. First, a charitable lead trust distributes part of its proceeds to a charity. Your client receives a tax deduction for these payments, and then your client’s beneficiaries receive the remaining principal balance.

Second, a charitable remainder trust prioritizes the distributions to your client or their beneficiaries before distributing funds to a charity. Your client first receives income from the trust, then at the end of the term of the trust or at the passing of your client, the charity receives the remaining balance.

Qualified Charitable Distributions

Retirement accounts are not a philanthropic vehicle, but there is a way for clients who are required to distribute earnings from their IRA or 401(k) to minimize taxes on their required minimum distributions (RMDs).

“My favorite way to encourage people to donate to charities is with their [RMDs] through a pretax retirement account,” Chrystal McKeon, a financial advisor at TSA Wealth Management in Houston, Texas, told us. “They can avoid income being added to their annual income but still make donations to charities that are important to them.” However, she noted the drawback: “You can’t take advantage of this until your [RMDs] kick in at 70.5” of age.

While clients would not receive a deduction for the amount donated, it’s reduced from the taxable part of the RMD. The limit on these distributions is $100,000 per year.

How Much Do Americans Give To Charity?

In 2022, the last full year for which solid data is available, Americans gave just under half a trillion dollars. Adjusted for inflation, that’s more than nine times more than in 1962. In terms of giving per capita, the 2022 figures were close to $1,500 compared with $333 in 1962.

How Do I Donate to Charity?

You can make a donation to charity in different ways. Most donors send cash via check or electronic payment, though different types of assets such as artworks, property, or financial instruments can also be given. A 2023 Giving USA report noted that 63% of donors preferred giving online with a credit or debit card, followed by 16% via mail, 10% via PayPal and other cash apps, 5% with a wire transfer, 4% in cash, 1% through a digital wallet, and 1% via text message.

What Are the Tax Benefits of Donations?

These will depend on the asset being donated and the vehicle being used. Cash donations are typically eligible as itemized deductions on your federal tax return. “While writing a check or using your credit card can do a lot of good,” Krauss told us, “donating this way is not the most tax efficient for most Americans. Using philanthropic vehicles can often create a situation where there is a larger tax break for the donor and hence reduces the cost of the gift.” Depending on the value of real property or financial instruments, you can also benefit from avoiding capital gains by donating assets that have appreciated in value.

The Bottom Line

Working with your clients to achieve their charitable intentions is a vital service and is simply part of financial advising. Charitable planning can provide financial benefits in addition to the fulfillment it supplies.

When helping clients with their charitable giving, be mindful of all your options regarding the types of gifts your client can give and the best vehicles for handling them tax-wise.

Read the original article on Investopedia.