Giving through donor-advised funds

Would-be philanthropists often find themselves confronted with a common paradox: the larger the value of their gift, the less likely they are to feel certain about the charitable beneficiaries.

In our experience, this paradox is especially prevalent with future gifts that are part of an estate plan, such as a bequest or life insurance. Clients often don’t know what they want their money to support after they’re gone.

This can mean avoiding estate planning. Conversely, it may produce a hasty embrace of a cause, a significant planned gift, and then lingering uncertainty or even regret. Buyer’s remorse may be an apt analogy.

Read: Flexible philanthropy

There are three issues that commonly arise with clients considering a significant gift to charity as part of their estate plan:

• They want to give, but they don’t know which charities they want to support.
• They feel nervous or uncomfortable making a large irrevocable gift.
• They don’t know who can help them.

Often the best solution to all three issues is a donor-guided “intermediate charity” such as a donor-advised fund. There has been a lot of promotion of donor-advised funds within the investment management world in the last decade. Here we explain how the structure helps clients plan their estates and become better, more confident philanthropists.

Best of both worlds

The classic estate plan for clients with charitable intentions is to make a gift by will, or bequest, to individual registered charities.

Another common approach is to name specific charities as beneficiaries, or both owner and beneficiaries, of an irrevocable life insurance policy. Direct gifts are appropriate in many cases, but for some they can lead to planning issues.

In our experience, one of the most common practical planning issues for clients with significant philanthropic intentions is uncertainty about the charities to select. Choosing one’s estate beneficiaries is a major decision, and uncertainty and delays are natural parts of the consideration process.

We have found charitable clients may be reluctant to commit to individual charities, feel guilty about not giving (enough) to family, and may be unsure about where to access knowledgeable support on charitable planning.

Read: Tax breaks a boon to charitable funds

With the value of estates growing and interest in philanthropy increasing due to a combination of demographic trends, social values and family size/structure, the number of clients facing these challenges is expected to increase over the next 15 years.

What charitable clients often require in their estate plans is a combination of planning certainty and philanthropic flexibility. The need for this combination is nothing new, which is why the wealthy have been planning their giving using intermediary charities, such as private foundations and charitable trusts, for centuries.

In the simplest terms, intermediary charities are simply “containers” that receive large gifts for future distribution for a variety of charitable purposes. The container offers structure and certainty at the planning stage and philanthropic flexibility going forward.

Donor-advised funds

While there are a number of different types of intermediary charities, in this article we’ll talk about donor-advised funds. Donor-advised funds are “giving accounts” at certain public foundations that enable the donor and successors to make recommendations about the use of the funds.

While some foundations with donor-advised funds only pay out income from invested capital, others enable grants of both capital and income. A donor-advised fund is designed to mimic many of the qualities of a private foundation, but is easier to establish and operate due to hosting by the already-established parent public foundation.

Read: Organizing endowments is tricky

An innovation of the community foundation movement, donor-advised funds are now available through a variety of public foundations, including some sponsored by financial institutions. Such foundations, such as Scotia Private Client’s Aqueduct Foundation, can enable grants of capital as well as income, which increases the donor’s options about how much goes to the intended charities.

While donor-advised funds are not a replacement for stand-alone private foundations in all situations, they are increasingly recognized as plan alternatives for their flexibility, simplicity and cost-effectiveness.

The primary advantage of utilizing donor-advised funds in estate planning is the ability to change beneficiaries after the will is written or the irrevocable life insurance policy is implemented. Unlike direct gifts to charity, the donor—or the donor’s family—may continue to choose how to distribute the funds after creating the plan or making the gift.

In practical terms, donors can implement their estate plans and then continue to research and make decisions about charities and causes they wish to ultimately support. This flexibility to alter beneficiaries without extra cost helps clients to implement their estate plans by removing the sense of finality.

Read: Charity toolkit

Another option when structuring the donor-advised fund is the “legacy” donor-advised fund. There are typically two steps to establishing it: First, the donor works with the host foundation to establish a shell fund. While practice varies from foundation to foundation, typically a fund deed is drafted that creates the donor-advised fund and allows the donor to name charities or causes that he or she wishes to support.

Second, the donor implements a gift plan, such as a gift by will. The gift in the will is typically a single clause that names the host charity and the donor’s fund. Even after the will is executed, the fund deed can be altered without cost. Indeed, donors often establish the fund and make preliminary designations that they may change or refine over time.

Legacy funds

Donor-advised funds in Canada have traditionally been structured as endowments, which means the donated capital is invested and only the income or a fixed annual payout is made to registered charities. Canadian donors also have the option of making immediate capital distributions at death to charities of their choice. This opens the door to legacy donor-advised funds with short-term mandates.

Short-term legacy funds are helpful in improving the flexibility of common gift plans, such as the gift of an irrevocable life insurance policy that names a number of charities. The advantage of making a charity the owner and beneficiary of a life insurance policy is that the donor gets receipts for each premium payment.

Read: Ensure endowments are properly funded

The disadvantage is the charities cannot be changed. Hence, in our experience, charitable life insurance policies have a high lapse rate because the beneficiaries cannot be changed to reflect the donor’s current charitable interest. By using a short-term legacy donor-advised fund, the life insurance policy is donated to the host public foundation and receipts can be issued annually.

The major difference is the donor can change the identity of the charities. When the donor dies, the death benefit is paid through the donor-advised fund and the capital is granted out to the named beneficiaries.

This structure provides administrative simplicity (with just one receipt each year), flexibility to change beneficiaries, and privacy in the planning process.

Staged distributions

A long-term or endowed donor-advised fund that is part of an estate plan is often used for similar reasons as a testamentary trust. Clients use trusts in their estate plan rather than an outright distribution because of concerns about the ability of beneficiaries to manage a gift. A one-time distribution of several million dollars — or even $100,000 — may not be in the best interests of the recipient.

The same can be true of a charity. While an outright distribution of $250,000 to a charity may, at first blush, be the simplest method of benefiting a beloved cause, such largesse may overwhelm a smaller charity and the charity may not be in a position to properly manage such a large one-time gift. Many people choose to stage distributions via a donor-advised fund for purposes of recognition or posterity, but also to take into consideration the longer-term needs of the charity.

Read: Guided giving

Another advantage of the donor-advised fund structure is the ability for donors to name causes as beneficiaries rather than individual registered charities. For example, it is possible to name animal welfare charities in a particular area.

It is not unusual for donors to live a long time after their estate plans are completed. During a donor’s lifetime, charities can close, new ones can be created, or existing ones can become less effective. Often, naming a cause and leaving detailed instructions for family members or the host foundation is the best way to satisfy the donor’s original charitable intent.

Expert advice

Many clients don’t know where to go for advice about charitable planning, especially as part of the estate planning process. They associate charities with fundraising, and fundraising with pressure and lack of privacy. While many larger charities have knowledgeable, professional gift planners on staff, many clients are nonetheless reluctant to involve charities in their estate planning. This is borne out by charitable sector research showing that charities have advance notice of only 10% of bequests.

Read: Philanthropy rounds out planning

A donor-advised fund allows discussions about philanthropy to take place in conjunction with other planning issues addressed by the client’s advisor. Within some foundations with donor-advised funds, a client can receive professional advice and guidance about charities, mission development and strategic giving.

Philanthropy is best learned over time in a protected space. Donor-advised funds help clients to become better philanthropists and may make giving more personally satisfying.

Elaine Blades, is Director, Estate and Trust Products and Services, Scotia Private Client Group. Malcolm Burrows is Head, Philanthropic Advisory Services, Scotia Private Client Group