All about foundations

One of the most innovative, flexible, and efficient ways to give back is by establishing a charitable foundation – either through your will or while you’re alive to run it before handing the duties over to your heirs.

It’s an option many wealthy individuals rarely think of, which is a shame because creating a charitable foundation can be one of the best ways to make significant long-term contributions to important causes.

What is a foundation?

In basic terms, a charitable foundation is a separate legal entity set up to make donations to registered charities. Pretty much anybody with assets can create one: after registering the foundation with the government and obtaining proper approvals, the donor makes an irrevocable donation of funds to the foundation.

This initial donation forms a pool of capital from which the foundation makes donations to various charities. As long as the foundation obeys the rules governing distribution of funds, the pool of capital can grow free of tax within the foundation.

How a foundation works

A foundation is governed by a board of directors, which usually consists of family members and close friends and associates of the founding donor. The board chooses when and where to direct distributions, as well as how much to give each year.

To maintain charitable status (including the ability to grow capital tax-free), the foundation must make minimum annual donations according to government rules. Currently, that minimum is 3.5% of all capital not used in charitable programs or administration. If the foundation’s assets fall below $25,000, however, there is no minimum disbursement.

Benefits of a foundation

Foundations offer a number of benefits over other charitable structures. Foremost is the potential for tax-free growth on assets it retains. This can be significant, since it lets you grow your initial contribution and make it last for decades.

Flexibility is another main benefit. Foundations can be established for any charitable purpose (subject to government guidelines), and can make regular contributions to specific charities, or case-by-case basis donations to a range of charities within a broad mandate.

Creating a private foundation can also help foster a family tradition of philanthropy and involvement with a particular charity. By involving other family members in the board of directors, donors can pass on values as well as valuables.

Drawbacks of a foundation

Despite these benefits, a foundation does have some disadvantages.

Creating and maintaining one can be costly. Professional legal advice is a necessity, and ongoing recordkeeping and accounting requirements can be significant. All of which means foundations are best suited to larger donors.

Requirements for an annual minimum disbursement can also be a drawback. To maintain their tax-exempt status, private foundations must donate a certain percentage of their assets every year to qualified charities. When you add administrative costs, it becomes possible for a foundation to suffer a 10% drain of capital every year.

A foundation is not a set it and forget it type of structure. It requires ongoing direction and guidance from founders, and regular participation by its board. For some donors, this kind of participation is exactly what they’re looking for.

But if you’re looking to be more hands-off with your giving, a foundation is probably not a good choice.