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Using Private Charitable Foundations to Build Your Practice
Roger Silk | 09-27-01
For reasons that I've outlined before, private foundations are one of the most important planning tools for advisors serving high-net-worth clients. I've previously focused on the benefits to clients of using private foundations. Now, I'll place an emphasis on how these tools can help advisors build a more profitable practice while serving their clients' needs.
Private foundations offer advisor benefits ranging from an increase in total assets under management to an ability to move clients from the low end back up to the high end of a fee scale. This column will address some of those benefits, with a subsequent column devoted to the rest.
Increasing Assets Under Management
When your client contributes to a private foundation, he or she receives an immediate income-tax deduction. The money saved on taxes, combined with the sum put within the foundation, gives the advisor more assets to manage with a foundation than without it.
Here's an example. Let's assume that a client with income of $1 million gives $300,000 to a foundation. The client immediately saves $135,000 in taxes (at a 45% rate). That tax savings translates into a larger asset base.
| Foundations Give Advisors More Assets to
Manage |
|
|
|
|
Without Foundation |
With Foundation |
|
| Gross Income |
$1
million |
$1
million |
| Taxable
Income |
$1
million |
$700,000 |
| Income Taxes |
$450,000 |
$315,000 |
| Net Available to
Manage |
$550,000 |
$685,000* |
|
| *Aftertax sum plus foundation contribution, a 25%
increase in total assets. |
A client may deduct up to 30% of adjusted gross income each year. For a client who takes advantage of the maximum allowed deduction, the savings can be significant.
Over the long run, the increase in total assets is even more dramatic. For example, assume that the client has beginning assets of $12.5 million, which earn 10% a year. The client plans to leave a bequest to charity, and with your assistance decides to create a foundation and begin funding it annually with 30% of annual income. (In this example, I have assumed that the client's income is all investment income, at the assumed growth rate of 10%.)
The client is giving to charity exactly what he or she would give anyway. The only difference is that the client is now taking advantage of the tax breaks. Total assets available for you to manage, and earn a fee from, increase by more than $26 million over 27 years. The table below summarizes the benefits.
| Additional Assets Under Management Over 27
Years |
|
|
|
|
|
Without
Foundation |
With
Foundation |
Additional
Assets
Under
Management |
|
| Total
Assets |
$44.5 million |
$71 million |
$26.6 million |
Moving from the Low to the High End of the Fee Scale
If you set your asset-management fees on a sliding scale, you may be able to increase revenues if your client shifts assets from a personal account to a foundation account. You'll only have this opportunity if you treat each account separately for fee scale purposes.
For a $5 million foundation, management fees could increase by $12,500 or more simply by moving the assets to the foundation and thereby starting over at the high end of the fee scale. The exact amount, of course, will depend on the fee schedule in place, as well as the amount of total assets and foundation assets.
Applying a separate fee schedule may be quite appropriate. The foundation is a separate legal entity, therefore not part of your client's personal assets. It's also tax exempt, and may well have different investment objectives than your client's personal account. Of course, if you desire, you may charge the client as if the foundation and the client's personal account were part of one pool of money.
Improved Portfolio Management
Like IRAs and other tax-deferred vehicles, a tax-exempt private foundation can make it easier for you to manage your client's taxable account. It's quite common for taxable accounts to accrue large capital gains, and money managers are often faced with the difficult situation of either holding positions they'd rather sell or selling the position and creating large capital gains taxes for clients.
If your client has a foundation, you can ease or eliminate this problem by encouraging your client to donate appreciated stock, especially stock that you're planning to sell, to the foundation. Using appreciated stock saves your client taxes twice--the client gets an income-tax deduction and saves on capital gains taxes. The combined savings can be as much as 75% for clients in the maximum tax brackets.
Private foundations also provide another bucket (outside of retirement accounts) in which to put income-producing assets such as taxable bonds, REITs, and high-dividend stocks. To the extent that such assets produce above-average returns, buying them can improve overall portfolio performance. And better performance means faster asset growth, happier clients and higher fees.
High-end investment professionals can use private foundations as one tool to establish
themselves in the lucrative market of providing philanthropic solutions to wealthy individuals and families. The market for private foundations has grown rapidly over the past 25 years, thanks in large part to tremendous wealth creation. Demand should continue to increase as the affluent become more sophisticated about tax planning and wealth management.
Currently, private-foundation management is an underused service with fragmented providers. Investment professionals who enter this field have a great opportunity to attract new business, provide a valuable service to existing clients, and raise their own incomes in the bargain.
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