Preparing Heirs for Responsibility, Not Just Access
Many of our clients express concerns about preparing their heirs for what they perceive to be the social responsibility of inheriting wealth. While not all clients share this view, those who do tend to feel particularly strongly about the need to prepare their descendants for this responsibility, which often translates to philanthropy. This article addresses how families with this worldview can prepare younger generations for inheriting wealth in a socially responsible manner.
A Simple Life Lesson
The Lilly Family School of Philanthropy at Indiana University conducts extensive research on philanthropic behaviors across lifespan. This seems intuitive enough, but their studies consistently suggest that early exposure to philanthropic activities can significantly influence one’s propensity to engage in giving and volunteering in adulthood.
Years ago, a colleague described to me the steps she took to educate her young children in social responsibility and philanthropy. In addition to modeling with her own giving, once each of her children attained eight years of age, during the holidays that child would be “given” $50 to donate to charity. My colleague would also teach that child how to use charitynavigator.org and guidestar.org to research the charities that most efficiently address the causes the child wished to support.
In this way, her children not only learned about philanthropy, but they also learned the importance of evaluating charities so they could give more effectively. As her children grew older, my colleague would periodically increase their annual charity allocation until, upon attaining 18, she would give $500 to the child for a donation to his or her favorite charity or charities. This simple lesson provides the framework for how the family can educate younger family members about social responsibility.
The Role of Legal Structures in Teaching Social Responsibility
Private Foundations
Wealthy families typically have at least one legal structure through which socially responsible education can take place. Historically, wealthy families have used private foundations as the cornerstone for this education. With a private foundation, heirs could serve as members of the foundation’s Board of Directors or, alternatively, could serve in a more limited advisory role (e.g., to determine specific grant recipients) to the Board. In this way, young family members can begin learning about philanthropy – and seeing its impact – before reaching their teen years.
However, utilizing a private foundation for this education has limitations. First, members of the Board have a fiduciary duty that is often overlooked. Thus, placing minors in this position is ill advised. Moreover, a role with the family’s private foundation is, at best, limited to that foundation’s charitable activities. If it is a grant-making foundation, the activities are limited to its grants; if it is an operating foundation, the heirs may also be able to experience the “hands on” charitable work being done by that foundation.
Regardless of the type of foundation (operating vs. non-operating), involving heirs in only the foundation has additional limitations. First, the family’s philanthropy is often accomplished through multiple avenues, not just a foundation. For example, the family may have one or more charitable trusts. Thus, the foundation offers only limited transparency into the family’s total philanthropy.
In addition, many wealthy families also utilize impact investing to create a social impact with their non-philanthropic assets. By definition, involvement limited to the family’s foundation can, at best, provide visibility only to the investments of the foundation. Since foundations frequently encompass only a fraction of the family’s wealth, visibility limited to the foundation does not give heirs a complete picture of how the family’s wealth – not just its philanthropic dollars – are impacting society. Ideally the heirs have transparency as to the totality of the family’s impact, with at least some say in the areas impacted.
As an aside, Donor Advised Funds have gained in popularity in recent years due to their simplicity, reduced costs, and lack of compliance headaches as compared to private foundations. In theory, an heir’s participation in the family’s donor advised fund would be substantially similar to their participation as an advisory member of the family’s private foundation’s board.
Private Trust Companies
A relatively recent legal development, the advent of Private Trust Companies, is changing how family’s address philanthropy and thus social responsibility with intergenerational wealth. A Private Trust Company (PTC) is a trust company controlled by the family and established specifically to serve as the trustee of the family’s irrevocable trusts. (PTCs are in response to the perceived conflict, particularly with younger generations far removed from trust creators, between descendants, on the one hand, and trustees, on the other.)
PTCs are currently available by statute in only a limited number of jurisdictions, but most of these jurisdictions not coincidentally are also the top U.S. trust jurisdictions due to their favorable trust laws. Our preferred PTC jurisdictions are Nevada, South Dakota, and Wyoming, but others also have merit.
General PTC management is provided by a Board of Managers, typically comprised of family members and independent outsiders, including an administrator in the selected jurisdiction. Significantly, the family can select which jurisdiction’s laws are most appropriate and advantageous for them, given their assets, goals and objectives, desire for a regulated versus unregulated PTC, etc.
More granular PTC management is provided by a handful of PTC committees, which often include the following:
Philanthropy Committee
Investment Committee
Owner Education and Family Governance Committee
Discretionary Distribution Committee
Amendment Committee
Audit Committee
The first three of the committees listed above may be limited to family members, and the Philanthropy and Investment Committees in particular create the opportunity to give heirs a holistic view of the family’s philanthropy and socially impactful investments; as the heirs age, their participation can increase accordingly, giving them increased visibility in their areas of interest. For younger heirs, sub-committees allow targeted, limited participation in these key areas.
Also relevant here, the Owner Education and Family Governance Committee creates the framework for participation and decision-making going forward. More specifically, this Committee develops the family’s policies and guiding vision and values that regulate family members’ roles, rights, and responsibilities with the family enterprise and with each other. The overall goal of these activities is to prevent the splintering of the family and family enterprise in future generations. Studies show that the potential splintering of the family is far more likely to dissipate intergenerational wealth than loss of capital, particularly as the family moves multiple generations away from the original wealth builder(s).
Conclusion
The legal structure(s) adopted by the family can have a significant impact on younger family members’ understanding of social responsibility and philanthropy. More so than a private foundation, a private trust company can give the family an ideal training ground for teaching social responsibility, and PTCs provide multiple avenues for encouraging areas of interest, including philanthropy and investments via committees and sub-committees. When generational wealth is at play, a PTC can provide a structure that encourages family harmony over generations, reducing the likelihood of wealth dissipation.
PTCs are not a panacea, however, and there are hard costs and administrative burdens the family should consider. But under the right circumstances, a PTC may provide the best structure for family involvement in social responsibility, while also providing a succession vehicle for the family’s intergenerational wealth.
The Bespoke Group provides strategic guidance at every step—helping you design an ideal structure and personalized giving strategy that reflects your values, ideals, and passions. We work closely with you to ensure that both your structure and philanthropy drive meaningful impact in the areas that matter most.
If you’re interested in learning more about Bespoke’s approach to private wealth management and how we can help you build a secure financial future, we invite you to reach out to us directly. We’d be happy to set up a confidential consultation at your convenience.
Thank you for considering Bespoke as your partner in wealth management. We look forward to the opportunity to work with you.
This information is intended for general educational purposes only and should not be construed as legal or investment advice.
In the previous article, “How to Align Passion with Impactful Giving“, we discussed the fundamental aspects of philanthropic giving. In this article, we take a closer look at the different ways to structure charitable gifts and the advantages of each structure. We’ll start by discussing the role of foundations.
Conduit and Operating Foundations
Private foundations provide many of the same benefits of public charities if they are structured and administered as a conduit foundation or as an operating foundation.
A conduit foundation must distribute 100% of all property contributed to it before the end of the first quarter in the year following the contribution. For example, if you contributed $1,000,000 to a conduit foundation in 2024, the foundation would have to distribute that entire amount by April 15, 2025. Conduit foundations generally only make sense for benefactors who do not want to be directly involved in ongoing charitable activities, and who have several known public charities to which they want to distribute large amounts.
By contrast, an operating foundation does not just award grants; it is actively engaged in providing services that advance the tax-exempt purposes of the foundation. Although operating foundations require higher administrative commitment and overhead, they provide more beneficial charitable deduction opportunities for donors as well as additional flexibility and control. Private operating foundations may also create opportunities for family members to receive reasonable compensation for services they provide to the foundation.
The classification of a private foundation is determined on a year-by-year basis based on the foundation’s activities. In some years a foundation may be treated purely as a “private non-operating foundation” subject to the lower deduction limits and excise tax mentioned above. In other years the private foundation may be managed as a “conduit foundation” if it meets the 100% distribution test. And in other years it may qualify as a “private operating foundation” if it meets a specific two-prong qualification test discussed below. The key is to strategically manage the foundation’s investments and activities in a way that allows it to qualify as an operating foundation – at least in years that are most advantageous.
Private Operating Foundations
The most complex type of private foundation is a private operating foundation. If a private foundation satisfies both parts of a two-prong qualification test, it will be deemed to be an operating foundation. The first prong of the test is a mandatory income test that requires the foundation to spend at least 85% of the lesser of the foundation’s (1) adjusted net income (which does not include long-term capital gain income or contributions made to the foundation) or (2) its minimum investment return, on the “active conduct” of charitable activities. If the foundation does not meet the income test in a given year, it will not be treated as an operating foundation for that year regardless of any other test.
If the income test is met, then the foundation must also satisfy at least one of the following additional tests:
Assets test – At least 65% of the foundation’s assets are devoted to the direct conduct of tax-exempt activities; or
Endowment test – The foundation distributes at least 2/3 of its minimum investment return in the active conduct of its tax-exempt activities.
The foundation may meet the assets test in some years, and the endowment test in other years. It must meet the income test every year. In each prong of the qualification test, expenditures and distributions must be made in ways that advance the exempt activities of the foundation itself, rather than through grants to other individuals or organizations.
Defining “Active Conduct” for the Qualification Test
The following are general examples of expenditures and grants that may qualify as “active conduct:”
Amounts paid or set aside to acquire or maintain assets used directly in the foundation’s exempt activities.
Reasonable administrative expenses such as salaries, travel expenses, and other operating costs necessary to conduct the foundation’s exempt activities.
Grants made as part of an active program in the foundation.
Grants made with continuing supervision by the foundation (and with the grant recipient reporting back to the foundation).
Tax on an operating foundation’s net investment income may be treated as a qualifying distribution.
By contrast, administrative expenses and operating costs that do not directly advance the foundation’s tax-exempt purposes do not constitute qualifying distributions.
As the above discussion demonstrates, private operating foundations are complex, but where you wish to fund a cause that is not being adequately addressed by other existing charities, a private operating foundation may be your best choice.
Private Non-Operating Foundations
A private non-operating foundation is a charity that primarily functions as a grant-making entity; i.e., it primarily makes grants to other charities rather than conducting its own operations. Like operating foundations, non-operating foundations are typically funded by an individual or single family.
Private non-operating foundations must annually distribute at least 5% of their net investment assets for charitable purposes, and their investment income is subject to a 2% excise tax. Moreover, when funding a non-operating foundation, you can deduct up to only 30% of your adjusted gross income for cash contributions, 20% for non-cash contributions (e.g., appreciated stock). Significantly, you can carry forward unused deductions for up to five additional years (i.e., six years total). Conversely, with a contribution to a conduit or operating foundation (or any direct contribution to a public charity), you can deduct up to only 50% of your adjusted gross income for cash contributions, 30% for non-cash contributions.
Donor Advised Funds
A popular alternative to non-operating foundations is the Donor Advised Fund (DAF). DAFs are separately identified accounts maintained and operated by public charities, known as sponsoring organizations. Once the donor makes the contribution, the sponsoring organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. Significantly, the donor requests that the sponsoring organization make a distribution, but the sponsoring organization retains the right to deny that request.
DAF assets can be invested and grow tax-free, potentially increasing the amount available for charitable grants. With a DAF, the donor receives an upfront charitable deduction for the amount contributed to the DAF (using the higher deductibility limits), even though the funds may not be distributed to charity for some time. In fact, this benefit has caused DAFs to recently come under scrutiny in Congress, with recent proposals requiring a minimum annual payout and maximum term before all funds must be distributed to charity.
Benefits of Giving Appreciated Assets
Donating appreciated assets, such as marketable securities, provides unique benefits to both the donor and the receiving charity. With a contribution of marketable securities, you will receive a tax deduction for the current fair market value of the stock and any public charity can easily sell the stock, convert it to cash, and not pay any tax. By donating the marketable security itself, as opposed to selling the security and donating cash, the donor may avoid capital gains tax on the sale of the security and receive a charitable deduction, while the charity receives the full value of the security.
Structures for Making Charitable Gifts
As discussed above, a Donor Advised Fund is one structure through which charitable contributions can be made but it may have some limitations. Some DAF sponsoring organizations permit the contribution of other types of appreciated assets, such as real estate or digital assets such as bitcoin. However, not all sponsoring organizations will accept these assets, and with few exceptions, most DAFs will require the sale of these assets upon contribution. Thus, it is imperative that you communicate with the DAF sponsoring organization to ensure it will accept the asset(s) you wish to contribute and/or, that it will hold the appreciated assets for some future sale date.
Capital Gains Deferral Trust
Rather than giving appreciated assets directly to a charity or DAF, another option is to give those assets to a specific type of charitable trust, recognized and accepted by the IRS, that can then sell the assets and not pay the tax. As a result, the full value of the appreciated assets can then be invested.
The trust then pays a fixed percentage, typically to you and/or your spouse for life, based upon the value contributed. At the end of that term, the remaining balance is paid to the charity or charities of your choice.
With this strategy you receive an income tax deduction for the present value of the hypothetical amount going to charity, and the assets are protected from your creditors and are outside of your estate for purposes of the estate tax. This is an excellent way to give to charity in the future, while providing you a tax-deferred income stream now.
For example, suppose as a Colorado resident you own Microsoft stock worth $1 million with zero tax basis. Thus, if you sold the stock today, you would pay $200,000 in federal capital gains tax (20%) and $43,300 in Colorado capital gains tax (4.33%), netting you $756,700. (In all likelihood, the net investment income tax would also apply, further reducing your net by 3.8%.)
If instead you transferred the stock to this type of tax-deferral trust, the trust would sell the stock and have $1 million to invest. There are several options but with the most common type, the trust would pay you (and your spouse, if any) a fixed annuity (say 5%) for your lives. Thus, you would receive $50,000 per year for the rest of your lifetimes(s), subject to tax.
Annuity to Charity Trust
Another option is to contribute assets to a different type of charitable trust–one that pays an annuity to charity for a specified number of years and then transfers the remaining trust balance to your heirs.
This type of trust is perfect to establish a long-term charitable giving strategy during your lifetime (for example, if you want to contribute $x to your favorite charity for the next 20 years).
And under certain circumstances, this trust can even provide you with an upfront income tax deduction for the present value of the annuities paid to charity. Additionally, assets within this type of irrevocable trust are protected from creditors and free of gift or estate tax.
Distributions Directly from Your IRA
If you are over 70 1/2, you can distribute directly to charity up to $100,000 per year from your IRA or qualified plan. This reduces or eliminates your required minimum distribution by the amount of the direct charitable contribution (up to $100,000) and, significantly, removes the direct charitable contribution from that year’s taxable income, thereby reducing your taxable income by the amount of the direct distribution to charity, up to $100,000. For example, if your required minimum distribution is $85,000, rather than taking that distribution and turning around and making a cash contribution to charity, consider making the distribution directly from your IRA. By making a direct contribution from your IRA, the $85,000 will not be included in your taxable income, thus reducing your overall taxable income.
Conclusion
Charitable giving is a dynamic process with many different strategies that can be levered to achieve a lasting impact and bring additional meaning to your legacy. The Bespoke Group provides strategic guidance at every step—helping you craft a personalized giving strategy that reflects your values, ideals, and passions. We work closely with you to ensure your philanthropy drives meaningful impact in the areas that matter most.
If you’re interested in learning more about Bespoke’s approach to private wealth management and how we can help you build a secure financial future, we invite you to reach out to us directly. We’d be happy to set up a confidential consultation at your convenience.
Thank you for considering Bespoke as your partner in wealth management. We look forward to the opportunity to work with you.
This information is intended for general educational purposes only and should not be construed as legal or investment advice.
The most meaningful philanthropy starts with a clear ‘why.’ For wealth holders, aligning giving with personal values and long-term vision is essential— not optional. This two-part series offers a blueprint for effective, values-driven philanthropy. In this first installment, we help you define what matters and where to begin. The second, “How to Structure Your Charitable Giving“, will provide a more detailed outline of various types of giving structures and alternative assets that can be gifted.
Identify Your Passion Causes
Some individuals come to us with fully formed views on philanthropy. Others have no idea how they should start their philanthropic journey. For this latter group in particular, the conversation often starts with the following question:
“Assuming a perfect world without limitation, what causes are you passionate about?”
Once you’ve defined these core causes, the question then becomes, “how can you best connect your philanthropy to these causes?”
Unsurprisingly, many individuals have limiting beliefs about their ability to make an impact on the causes they care about. These beliefs include thoughts like: my cause is too large or, conversely, my cause is too small; I don’t have the resources to impact my cause; my cause is too difficult to impact; impacting my cause requires disclosing my identity; etc.
In some cases, these limiting beliefs may reflect objective challenges, but more often, they are based on subjective perceptions. For example, one of our clients is deeply passionate about addressing racial and gender inequality, two massive issues that seem insurmountable, even with unlimited resources. However, through several conversations with various experts, the client learned that human trafficking is a socio-economic issue that disproportionately impacts women and people of color. This insight lead the client to address human trafficking in a particular region close to home by funding a center for victims of human trafficking. Today, that center serves a significant numbers of victims daily, making a meaningful impact on the community.
Another client couple is passionate about their church, a relatively small denomination with diocese in only a handful of U.S. cities. Given the small size of this church, the clients require absolute anonymity in making large contributions to their church. Through the assistance of a philanthropy consultant, we ensured total anonymity with their contributions. Further, after numerous conversations we determined that multiple smaller contributions over many years would likely have a much greater impact than a fewer number of large contributions, given the relatively small size of the endowment – and vision – of the church.
Once we align the client’s passion causes with potential philanthropy, we then explore the many ways in which the client can approach that philanthropy from a structural perspective. The first question is, are there charities that are addressing this cause, or does the client need to create a charity to address it? From there, we discuss various types of private foundations and their best use case to fit the client’s objectives.
Private Foundations Generally
At the risk of oversimplifying, there are three general classifications of private foundations: 1) private non-conduit, non-operating foundations, 2) private “conduit” foundations, and 3) private operating foundations. Of these, conduit and operating foundations enjoy many of the same benefits that public charities provide. Non-operating, non-conduit private foundations provide lower levels of deductibility and are subject to additional layers of tax at the entity level.
Private foundations are an excellent tool for managing the family’s philanthropy and incorporating younger family members into family wealth decision making. It should be noted, however, that private foundations are complex with significant regulations and administrative costs, and they are therefore not right for every family.
Ways to Give: Cash and Appreciated Asset Contributions
Cash contributions provide the immediate liquidity to fund charitable operations and thus are vital to many charities. Cash contributions also provide the highest level of deductibility against your adjusted gross income. However, there are other ways you can give . . . which may be advantageous to you from a tax perspective and may allow you to incorporate giving to your passion causes as part of your estate planning.
Rather than donating cash or a check, consider contributing appreciated assets such as marketable securities, which include stocks, bonds or certificates of deposit. Contributing appreciated assets provides additional flexibility and tax advantages when implemented within the correct structure.
Conclusion
A meaningful philanthropic journey begins with clarity of purpose—identifying the causes that matter most and aligning them with a strategy for impact. From there, the focus shifts to execution: how to channel resources effectively, and which vehicles— whether foundations, trusts, or donor-advised funds— are best suited to achieve that impact. This is typically an iterative process that sometimes takes place over many conversations, often over several months or longer. Further, one’s philanthropy is not static and may evolve and/or expand over time.
In this way, philanthropy can not only produce a significant impact, but it can provide tremendous meaning to those who engage in it. Many of our clients find unending joy knowing that they are truly making a difference. At The Bespoke Group, we take great pride in helping individuals and families find this joy.
If you’re interested in learning more, please read “How to Structure Your Charitable Giving” where we break down different types of foundations and trust structures, and how to identify what structure will best serve your values and philanthropic goals.
If you’re interested in learning more about Bespoke’s approach to private wealth management and how we can help you build a secure financial future, we invite you to reach out to us directly. We’d be happy to set up a confidential consultation at your convenience.
Thank you for considering Bespoke as your partner in wealth management. We look forward to the opportunity to work with you.
This information is intended for general educational purposes only and should not be construed as legal or investment advice.
