In our view, it is always a good time to assess your philanthropic priorities and consider setting your plans in motion.

While many people think about charitable giving toward the end of the year, when they have a sense of their annual income and tax situation, we believe that such planning should take place within a long-term framework. Moreover, it is possible to both assist charities and structure gifts to achieve positive tax results for yourself and your family. In other words, any time of the year may be appropriate to begin laying the groundwork for a charitable program.

With this in mind, various planning vehicles can provide structure to your charitable efforts, from the simple to the elaborate. In this article, we outline a few of them to assist in potential conversations with advisors as you lay out your plans.

Donor-Advised Funds: Tax Advantages, Deferred Choices

Donor-advised funds (DAFs) are public charities that provide a simple platform to manage a giving program, offering the ability to make current tax-deductible donations even when you have not yet identified charitable recipients. There may be various reasons for making a current gift, including a desire to donate rather than sell an appreciated security at a gain.

To establish a DAF account, you make a contribution to the DAF, which creates a separately managed account for the benefit of the charities you select. You can take an immediate tax deduction for the value of the assets transferred, and then wait to think about the ultimate charitable recipients while the DAF invests the assets. There are usually a variety of investment options from which to choose, and the financial institution offering the DAF handles all the administration. When ready, you make a grant recommendation, which the DAF executes.

Some DAF accounts can be established with relatively low minimums, and the gifts to your recommended charities can be in small amounts or as large as you wish. Many DAFs will accept contributions of privately held securities and real estate, in addition to cash and publicly traded securities. This flexibility allows you to select the most appropriate assets to fund the DAF account, including those impractical for a one-off gift to charity.

There are some limitations to DAFs. They can only make grants to IRS-qualified, U.S.-based public charities, and may require a certain number of transfers to grantees within a period of years. Also, the DAF has final say on whether to honor your grant-making request. While it’s rare for the DAF to turn down a donor’s recommendation to benefit a specific charity, it is a possibility. Additionally, the investment options can be relatively limited.

Private Foundations: Flexibility and Control

If you wish to become more involved with grants to charities through your own organization, a non-operating private foundation can provide a high degree of flexibility and control. It can enable you to make larger, more material donations, facilitate your connection with the broader community and in general foster a long-lasting legacy.

A private foundation is a distinct legal entity that allows you, as its creator, to retain control over how assets are invested and distributed. The foundation can be funded while you are alive or as a gift at death, which can potentially reduce your taxable estate.

Various expenses may apply, including initial legal fees to form the entity—either as a trust or corporation—and to prepare and file the necessary paperwork to attain tax-exempt status. Every year, the foundation must give away at least 5% of the average value of its endowment to qualifying charities.¹ In addition, it must submit an annual filing to the IRS that includes fiscal data, trustee or board member names and a list of annual grants. Income tax deductions for donations are capped at a lower percentage of annual income for gifts to private foundations than to public charities, including DAFs, although the same carryforward rules apply. The foundation’s net investment income is subject to an annual excise tax.

Like DAFs, private foundations can receive a diverse array of assets. However, it is typically preferable to fund them with publicly traded securities held over one year to ensure that you can take a deduction for the full market value of the donation.

As the creator controlling the entity, you have broad discretion in choosing portfolio managers and investments, as long as they are prudent. Foundations also have considerable latitude in grant-making, and can contribute to varied recipients, including foreign organizations (which is not the case for a DAF). Thus, if you are looking to support a non-U.S. charity, you can still receive a charitable deduction in funding the foundation, even though a direct gift would not typically be deductible.

A private foundation may be an appropriate choice for those who wish to involve family in philanthropy. For example, children may become board members to help determine which charities will receive grants, and, if employees, may be eligible for reasonable compensation and medical benefits. (All such activities are subject to certain self-dealing restrictions.)

CLATs: Estate Planning and Charitable Benefits

An array of additional planning structures may work to combine estate planning and charitable objectives. In the current climate of unusually low interest rates, one with particular appeal is the Charitable Lead Annuity Trust, or CLAT, which can benefit charity and pass future appreciation to individual beneficiaries without incurring any estate or gift tax.

A CLAT is an irrevocable trust established for a term of years or a period keyed to an individual’s life that provides a charity or charities you name (and can change during the term of the trust) with an annual payment. This payment is fixed when the trust is created and does not vary even if the value of the trust does. At the end of the term, any remaining assets will pass to the noncharitable remainder beneficiaries, typically your children or trusts for their benefit, as directed in the trust agreement.

Like the more common Grantor Retained Annuity Trust, the annuity can be structured so that the total annuity payout over the trust term is equal to the initial value of the assets placed in the CLAT plus the IRS’s assumed growth rate—the 7520 rate—so that there is no gift tax due upon creation. When the CLAT term ends, any appreciation remaining in the trust after the final charitable payment passes to the noncharitable beneficiaries free of gift taxes.

A CLAT is typically structured as a grantor trust, allowing you (as the grantor, or creator of the trust) to receive a current income tax deduction equal to the present value of all annuity payments. You are responsible for all the income tax payments on CLAT activity during the term.

If you have already given the maximum deductible amount to charity, you may wish to consider creating a non-grantor CLAT. In this case, the trust pays the taxes on all its income and receives the charitable deduction on income and capital gains that are paid out to charities as part of the annuity. (You avoid recognizing the income, but do not get the deduction.) This provides a way to accomplish philanthropic goals with tax efficiency that might not be available otherwise.

Periods of low interest rates enhance the opportunity for wealth to pass free of gift taxes because any appreciation in excess of the IRS’s 7520 rate—0.6% in February—inures to the benefit of the noncharitable beneficiaries. As suggested by the accompanying hypothetical example, increased returns within the trust can help ensure payments to the charity and potentially enhance outcomes for noncharitable beneficiaries.

Source: Neuberger Berman, NumberCruncher. These hypothetical results shown are for illustrative purposes only. They are not intended to represent, and should not be construed to represent, a prediction of future rates of return. The illustration does not reflect the fees and expenses associated with managing a portfolio. If such fees and expenses were reflected, results shown would be lower. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

Other Ideas

Beyond the more structured approaches above, you may prefer to make donations on an individual basis, preferably within the broader framework of your philanthropic plan.

Cash gifts. Cash donations are often the easiest way to make a charitable gift, whether in large, focused amounts to an individual charity or spread across several recipients. However, we believe there are more tax-efficient ways to engage in charitable giving.

Appreciated securities. A donation of appreciated publicly traded securities can provide additional benefits, as you not only can receive an income tax deduction for the full fair market value of the securities donated, but also avoid paying capital gains tax on any unrealized gains that otherwise would have been payable upon the sale of such securities. Keep in mind that you must donate long-term holdings that generate long-term capital gains in order to receive a full-market-value deduction.

Required Minimum Distribution donations. If you are age 70½ or older, you can donate up to $100,000 of your retirement distribution to charity this year and avoid paying taxes on those dollars. Rather than counting as a deduction, the amount gifted to charity is excluded from income. This makes the strategy particularly beneficial for those who take the standard deduction instead of itemizing.

Building Your Plan

In approaching philanthropy, we believe coherent planning and skillful execution are crucial in addition to having confidence in an organization’s mission, approach and financial condition (see Know Your Nonprofit). There is no one correct approach, but early consultations with advisors can help you identify which method of giving is most appropriate for you.