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Multi-Generational Models That Work

November 05, 2015

This is the third post in a three-part series. Click here for part one, "Going Long: Building a Legacy of Family Philanthropy," and part 2, "Raising the Next Generation of Givers."

Multigenerational_philanthropyIf you have not read the first two posts in this series, I encourage you to take a few minutes to do so now. In this final post, I will compare three alternative models for structuring family philanthropy, each of which — properly planned and managed — can produce meaningful and satisfying long-term results, and will conclude with a few practical tips. But before diving in, allow me to note the obvious:

The information provided here is general and educational in nature and is not intended to be, nor should it be construed as, legal or tax advice, neither of which the author is qualified to provide. Readers are strongly encouraged to consult with their tax advisor or attorney before making significant charitable decisions or establishing a charitable giving program.

Now that we've gotten the disclaimer out of the way, let's compare some of the key features and benefits of donor-advised charitable funds, private/family foundations, and supporting foundations — three popular structures for managing current giving and/or multi-generational family philanthropy.

Donor-Advised Charitable Funds

A donor-advised fund is a charitable savings account of sorts, established within and managed by either a traditional public charity, community foundation, or, more recently, a nonprofit subsidiary of a commercial financial institution (Vanguard and Fidelity being among the largest in this category).

Donors can brand their donor-advised fund and name successors or charitable beneficiaries, while contributions are placed into separate donor-advised fund accounts where they can be invested and grow tax free.

The donor-advised fund allows individuals to make charitable contributions, receive an immediate tax benefit, and then recommend grants from the fund over time. (More on that later.)  Contributions are irrevocable, and donors can contribute to the fund as frequently as they like and then initiate grants to their favorite charities when they are ready, with no minimum annual distribution requirement.

Donors receive an immediate tax deduction when they make a charitable contribution to a donor-advised fund. Liberal deduction rules allow up to 50 percent of adjusted gross income (AGI) for gifts of cash and up to 30 percent of AGI for gifts of appreciated securities, mutual funds, real estate and other assets; there is also a five-year carry-forward deduction on gifts that exceed AGI limits. By donating appreciated assets held for more than a year to a donor-advised fund, donors can generally avoid capital gains taxes.

Donor-advised funds are not required to file separate tax returns or accountings. Operating expenses are generally limited to investment and transaction fees, and there are usually no other significant costs associated with such funds.

Prospective donors need to be aware, however, that the continuing relationship to the fund is advisory only, with grants being "recommended" by the donor to the nonprofit fund holder, who retains ultimate legal control and approval authority over all distributions.

Donor-advised funds can be a low-cost, easy-to-use vehicle for current or even multi-generation charitable giving, although the lack of independence and the limitations on grantmaking and governance authority make them generally less attractive to larger donors seeking to establish a long-term mechanism for their family philanthropy.

Private/Family Foundations

If a donor-advised fund is the simplest but least autonomous vehicle for managing charitable family giving, the private foundation is the Rolls Royce of multi-generational family philanthropy structures.

Family foundations are one form of private foundation as defined in the tax code: IRS-approved independent nonprofit organizations established and funded primarily by private contributions for the purpose of supporting charitable activities through grantmaking to other nonprofit organizations and programs. One or more family members serve as officers or board members of the foundation, and they or their relatives and friends — and, in many cases, second- and third-generation descendants — participate in governing and/or managing the foundation over the course of its lifespan.

Tax deductions for cash gifts to private foundations are generally capped at 30 percent of AGI per year, and 20 percent for property gifts. Assets transferred to a private charitable foundation, and appreciation of invested funds held within the foundation, are exempt from capital gains or estate taxes.

In contrast with donor-advised funds and supporting foundations, which are not subject to IRS minimum distribution requirements, private foundations are required to distribute 5 percent of their assets annually, calculated on the value of both financial holdings (stocks, bonds, cash) and non-cash assets (real estate, art collections and the like) over a rolling three-year period. Distributions in excess of 5 percent can be carried forward over a five-year adjustment period.

Beyond these minimum annual distribution requirements, which can be problematic for foundations holding substantial illiquid assets, private foundations must comply with all the regulations governing other nonprofit organizations: securing and maintaining tax-exempt status; annual state and federal tax filings; accounting and audit regulations; banking, accounting, and investment management; insurance coverage; staffing costs; start-up and periodic legal fees; and other operating expenses. In addition, private foundations are subject to an annual federal excise tax of 1-2 percent on net investment income. Clearly, a Rolls Royce is not for everyone.

On the other hand, private family foundations provide substantial benefits that make them an attractive option for certain high-net-worth families. Donors can make tax-deductible donations and still remain in control of the investment and management of the funds as trustees/board members. Trustees have wide-ranging autonomy, within the confines of IRS and state regulations, to establish grantmaking and investment policies; to specify bylaws and provisions for multi-generational governance; and to appoint professional staff, advisers, and managers to lead the day-to-day activities of the foundation.

In short, private family foundations provide a fully independent — although costly and labor-intensive — framework and identity for community engagement, and can serve as an excellent platform for succeeding generations of philanthropists and community leaders. For good reasons, they are often the vehicle of choice for families of major wealth, but are generally less suitable — and less practical — for most others.

Supporting Foundations

In between the do-it-yourself, one-size-fits-all donor-advised charitable fund and the costly, complex but fully independent private family foundation lies a less-known and underappreciated middle ground: the supporting organization as it’s known in the IRS lexicon, but to which we’ll refer here as the supporting foundation.

(Full disclosure: I'm a big fan of supporting foundations — having helped create and served on the board of several — which combine many of the most attractive benefits and features of the private foundation with the administrative and technical supports available to donor-advised funds.)

A supporting foundation is a tax-exempt charitable organization that is created under the auspices of another public charity such as a community foundation or a similar entity (known as the "supported organization").

While the supporting foundation enjoys much of the independence of a private foundation — the freedom to appoint family directors or trustees, set its own investment and funding policies, and make independent grant decisions — it is one of the few organizations that receive the benefits of public-charity status without having to satisfy the IRS public support test, comply with minimum distributions, or pay the federal excise taxes required of private foundations.

The IRS logic holds that the scrutiny provided by the overseeing public charity justifies exemption from some of the special rules and regulations to which private foundations are subject. This opens up many benefits to certain donors, including those who might want to gift closely held stock or other assets that cannot be held by private foundations.

In exchange for these relaxed IRS rules, the supported organization must hold a simple majority of seats on the supporting foundation's board in order to satisfy the technical control requirements of the IRS, and its grantmaking must support activities aligned with the purposes of the supported organization.

In most cases where, for example, the supporting foundation is affiliated with a community foundation-type entity, the mission and purposes of the supported organization are usually sufficiently broad as to allow wide grantmaking leeway to the supporting foundation. As a practical matter, the donor family enjoys significant deference, as it is obviously in the supported organization's self-interest to exercise its authority with a light hand and in a way that respects the goals and needs of the family.

Perhaps the greatest benefit of a supporting foundation is precisely its affiliation with an experienced and well-staffed host foundation or charity. The availability of expert staff resources — in management, grantmaking, investment, and financial oversight — is a huge asset to families, particularly to supporting foundations that intend to "go long" — that is, to involve future generations in overseeing the activities of the foundation.

Private foundations too often lose their way when the founding generation is no longer in the room to keep the ship on course. The stability provided by a host community foundation or charity and its professional staff can play a pivotal role in mediating differences among succeeding board members and in helping the family balance the goals and priorities of the founders with those of the next generations and with changing needs and times.

Tips for Making Multi-Generational Family Philanthropy Work

Tip #1: Creating a multi-generational family legacy of philanthropy and social responsibility is a lifelong enterprise that starts on day one of a family's life. It can't — or shouldn't — begin with a discussion between aging parents and their adult children about creating a charitable fund.

As I argued earlier, in teaching philanthropy (as in most other areas of life), adults need to authentically model the values and behaviors they hope to instill in their children. A curiosity about the world around us, a social conscience built on respect for others and a concern for their well-being, and a spirit of generosity, volunteerism, and giving are building blocks of such a family legacy. These are not genetic traits passed down in our DNA. They are muscles that need to be exercised and developed.

Tip #2: Parents and other relatives hoping to engage their next generation(s) in family philanthropy need to create space — from early on — for divergent social and political views and, later, for divergent charitable interests and priorities.

I have been privileged to serve as an outside director of a supporting foundation created and led by fairly conservative parents who have respected the remarkably diverse choices and interests of their adult children. Their family foundation table serves less as a place where everyone reaches consensus and more as a place where respect is demonstrated through the diversity of grantmaking across a wide range of interests and priorities.

Tip #3: Don't assume that succeeding generations will understand your values, motivations, or charitable intent. Create a charitable legacy document — or an ethical will — to commit these ideas to writing. Whether a few paragraphs or book-length, your children and grandchildren will treasure it forever.

Each succeeding generation will add its own unique chapter to the family's philanthropic legacy. Issues that were once the focus of the founder's giving will have evolved or perhaps even been resolved, and new challenges/opportunities will have emerged. But family philanthropy works best — and will be most gratifying to family members — when new priorities and decisions are informed by the vision of those who came before.

Tip #4: Work in the present but plan for the future. Intra-family relations invariably change and evolve, sometimes for the worse in the absence of parental mediation and leadership. Successful and sustainable structures and policies anticipate those changes and take them into account.

Second- and third-generation family foundations often succeed or fail based on the mechanisms that have been put in place for facilitating intra-family collaboration and managing conflict. The importance of building a team of investment, legal, and charitable advisers (in the case of private foundations), or drawing on the vast array of community philanthropic resources for learning, guidance, and leadership (as is one of the many benefits of supporting foundations) cannot be overstated.

Conclusion

Successful multi-generational family philanthropy doesn't magically materialize. It happens when the various components discussed here are carefully planned and put together. If I were to reduce the formula for success to a simplistic equation, it might look something like this:

Social consciousness + family activism + a sound family philanthropy structure + reliable partners/advisers + a culture of respect for difference/diversity = successful multi-generational family philanthropy.

The largest wealth transfer in American history is now under way, with more than $50 trillion expected to change hands over the next generation or two. At the end of the day (figuratively and literally), each of us has the right to plan for the transfer of our share of those assets — however small or large — beyond our lifetime in the way we see fit.

Needless to say, my view is heavily biased by a fundamental belief that inherited wealth is not only a means for next-generation personal gratification, but carries with it a serious responsibility for contributing to the public good. And creating a legacy of shared family giving is one of the best available ways of preparing future generations for exercising that responsibility.

There are, of course, legitimate arguments in favor of giving now (going big) rather than committing substantial assets to long-term family philanthropy (going long). And there are certainly risks and unknowns associated with entrusting future generations with the philanthropic checkbook.

But it is my considered opinion that the risks and opportunity costs of spending-down often outweigh the benefits, however attractive those benefits may seem in the moment. And the readily available philanthropic supports that I've outlined — especially those associated with supporting foundations — can and do substantially mitigate many of those risks.

As Robert F. Kennedy once said, "Let no one be discouraged by the belief that there is nothing one person can do against the enormous array of the world's ills, misery, ignorance, and violence. Few will have the greatness to bend history, but each of us can work to change a small portion of events. And in the total of all those acts will be written the history of a generation."

All the more so when families commit to changing that portion of events across the generations — for, to paraphrase RFK, in the total of all those acts will be written the history of humanity.

Headshot_ami_nahshonAmi Nahshon is principal consultant at Ami Nahshon Strategic Consulting, where he offers consulting and coaching services designed to help nonprofits, foundations, and their leaders optimize their mission, strategy, and performance.

Sources consulted for this article include the National Philanthropic Trust, the Council on Foundations, and the Planned Giving Design Center.

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